If the global financial crisis (GFC) taught us anything – and it taught us a lot – it’s that sometimes the conventional thinking can be well wide of the mark. Many of the concepts on which portfolio construction is based were given a real-world stress test during the global market meltdown. The same thing happened again in the first week or two of August this year.
A lot of things we assumed to be true turned out to be anything but.
Graham Rich, publisher of Portfolio Construction Forum, says that today, more than ever, financial planners need a core set of beliefs that they can rely on to help navigate clients through uncharted waters.
Rich says planners need to develop a way of assessing and accommodating unprecedented economic events within a method for constructing robust portfolios. And rather then focusing on a macro view of the world at the expense of a micro view, or on a micro view at the expense of a macro view, planners need to be able to focus on both at the same time.
As Rich puts it, rather than being in a position where they cannot see the forest for the trees, they need to learn to see both.
Rich says developing a set of principles about portfolio construction helps to provide a context in which to digest the latest news or developments in financial markets.
For example, when Standard & Poor’s downgrades the US Government’s long-term debt rating from AAA – something that has never happened before – advisers need a set of principles that will guide their response.
‘A lot of their core beliefs were shaken, a lot of the practices they were engaged in were found to be wanting’
Otherwise, they run the risk of an incorrect or knee-jerk reaction that does their clients no favours at all.
“It’s fair to say that in the run-up to the GFC – 2006, ’07, ’08 – there was a reasonable body of opinion which I think we gave fair exposure to, which said the way things are travelling, this cannot last; that the way things are travelling has a set of risks associated with it – and these are the things you ought to be thinking about when it comes to putting portfolios together,” Rich says.
“The valuations we were seeing in various aspects of the market were distorted. That was a phase, if you like.
“Then we had 2008, 2009 and 2010, where it became abun- dantly obvious that, as we describe them, portfolio construction practitioners – people who have a role in designing and building and managing investment portfolios, whether they’re research house analysts, dealer group researchers, investment committee members – were in shock.
“A lot of their core beliefs were shaken, a lot of the practices they were engaged in were found to be wanting.”
Rich says he does not mean to say,“ha, ha – told you so”. He says the realisation that what had worked in the past may not necessarily work in the future was a realisation shared by “all of us”.
“So for the last three or so years, we’ve been saying we need to get into the helicopter, we need to look at the bigger picture of what’s going on, we need to think about how we manage ourselves through and out of this crisis.
“Building on phase two, if you like, is now a proposition that says, OK, we’ve reflected on the fact that macro matters, but let’s not swing the needle too far and say the only thing you need to worry about is the macro picture, the long-term picture, the top-down approach,” Rich says.
“In fact, what we need to think about is an appropriate blend of macro and micro, of the strategic issues as well as the tactical issues.
“This financial crisis has shaken us to the roots, [and made us] revisit our core beliefs, reassess our philosophy and make sure our investment policy – our processes and practices – align tightly with the beliefs that we have reassessed.”
Rich cites as an example the rise and rise of exchange-traded funds (ETFs) and the growing belief that they’re the ideal investment vehicles in a post-Future of Financial Advice (FoFA) world.
“As FoFA comes along and says you can’t do this, you can do that; as markets are uncertain [and] as your ability to secure revenue for your practice in financial advice is challenged, do not swing towards, for example, ETFs, just because they look like the latest and greatest thing, and just because [it seems like] that’s a way of saying I can give you lower cost and I can give you market stuff without me having to take the risk of deciding is this a good fund or a bad fund,” Rich says.
Rich says an aim of the 2011 Portfolio Construction Forum Conference is to en- courage planners to “spend some time thinking about what are the big issues, and what are the immediate things we should be taking into account when it comes to putting portfolios together – or, to use the analogy, let’s think about the woods, the forest, the big picture; and the trees”.
“Because as we’re walking our way through deep in the forest, it’s all very well knowing where you’re going, but if there’s a snake on the rock in front of you, you’re dead,” he says.
“You’ve got to take into account both issues. Markets are volatile and becoming more volatile and subject to more movement than we’ve experienced. But knowing how to handle that requires you to have a micro view and macro view.
“That’s what this conference is all about.”
The 2011 Portfolio Construction Forum Conference is on in Sydney today and tomorrow. Professional Planner is an official media partner to the event.
