Sometime during the past 30 years the funds management industry lost sight of what it was really meant to be doing for investors, according to Alan McFarlane, chief executive of fund manager Walter Scott, a keynote speaker at the 2009 Securitor convention in Darwin.

McFarlane says investing was not always about relative performance, and fund managers’ business risk was not as often put before the best interests of investors.

But that’s increasingly the case today and it helps explain why too many professional managers, and advisers, lost sight of risk on behalf of their investors and clients.

McFarlane says prior to the 1950s investing was “a rich man’s game”. But after the Second World War there was a rapid and extensive democratisation of assets and wealth.

“Along the way, we needed to get a quick, shorthand way of understanding if our investment portfolio was doing well or badly,” he says. The answer was to develop an immense number of indices – MSCI calculates an estimated 100,000 equity market indices – against which to compare portfolio returns.

But the consequence was that instead of focusing on which returns are likely to give the best risk and rewards trade-off over an investors expected investment time horizon, the game became managing portfolios so they were “never more than two standard deviations” away from the index return and, hence, that the fund manager’s business was never at risk.

From there, mainstream funds management became all about distribution. But the disservice often visited upon clients by financial planners is to sell them funds offered by fund managers whose main aim is to never perform too far from an index, rather than to manage money truly with investors’ best interests at hearts.

“If it were up to me, I’d ban all commissions paid by fund managers to financial planners,” McFarlane says.

“I think embedding fees in [the form of] commissions and trails is wicked.”

McFarlane says financial planners must think and act independently of fund managers, and must understand intimately the history of financial markets risks and returns – not just for the last five or ten years, but for much longer periods.

He says some sort of education in “financial history” should be compulsory, so that a deeper understanding is gained of the history of returns, the history of the interaction between returns and inflation, and the power of compounding in equity investing.

“In terms of the advisers I meet around the world, the cohort in Australia is easily at the top end of the spectrum,” McFarlane says. He says that’s because the structure and regulations of the industry in Australia mean planners have “been hammered into getting it right”.

But he says “30 years of a bull market has left that down at the bottom of the list of things that are interesting to study”.

McFarlane says “so many people think that you make money in equities by trading them for gain”.

“But the lesson of history is that the great engine of equity returns is compounding,” he says.

“Corporates pay dividends, and you reinvest them.”

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