The pursuit of financial security has shifted from a “feeling landscape to a fact landscape” and advisers’ conversations with their clients must reflect this, says Tim Noonan, managing director of capital markets insight, Russell Investments.
He points to a flawed definition of risk within the industry, arguing that views of risk as it relates to returns are basically unchanged since Harry Markowitz outlined his theories in 1959.
In a presentation delivered last week during the PortfolioConstruction Forum, Noonan says he believes there are now superior frameworks coming into focus.
“I think that what we’ve been through in the form of the global financial crisis, and what we continue to go through….is that now, you can’t say 100 things, you’ve got to say one thing.
“It’s my view that financial security has moved from a feeling landscape to a fact landscape. Unless you can tell someone whether or not they have enough, you can’t go on to the next gate,” he says.
Noonan points to a study that shows 55 per cent of investors who work with financial planners report that they have no financial plan.
“What the hell are they doing? Of course they have a plan. What they’re really saying is they don’t recognise the plan, they don’t see themselves in the plan, they don’t think it’s their plan.
“We solve problems, at least in the baby boomer generation, by buying products. So we have to transform this conversation.”
Annuatisation is key
“The ultimate form of stability is to annuatise…why don’t people annuatise?” asks Noonan.
One of the reasons he points to is that annuatisation removes the ability for the investor to change their mind.
However, a key advantage he observes in this approach is the ability “to exchange your longevity risk for the longevity risk of the actuarial pool”.
Risk assessments and discussions around clients’ funded status should underpin the conversations financial advisers have with their clients, according to Noonan.
“There is a whole series of the investing public who think that the way to get yield is to buy it in the instrument itself, rather than to create more efficient portfolios and harness from them – this is our great challenge.
“Explaining to people that these assumptions are going to cost them a lot of money…[and] actually lower their standards of living, unless we give them another way to do it,” he says.
New tools not the answer
Noonan also makes the point that he believes creating new tools and products is not a solution.
“We need more financial planning tools like we need more navels. The problem is, they don’t create information that leads to a different action,” he says.
He refers to what he sees as a key differentiator between individuals and institutions: the ability to pool mortality risk.
“Individuals can’t pool their mortality risk, but they can actually price their mortality risk.
Noonan suggests financial advisers need to “surveil their clients’ funded status… by essentially measuring what is the surplus for the deficit relative to that amount I would need to buy the annuity”.
“The risk you can take in your portfolio should really be related to the changes in your funded status.
“Our challenge is to move through this membrane of balancing current consumption with future consumption…funded ratio tools are a magnificent innovation…[that are] transformative to the relationship with the client.”
