Rising interest rates and inflation has put the spotlight back on the need for educating clients about market risk and patience, according to an investment manager.
Interest rates have been making news lately, after investors spent the last couple of years expecting rates would not rise as fast or as much as it has this year.
However, Atrium Investment Management head of risk Glen Foster tells Professional Planner this was never guaranteed.
“This year has been interest rate risk. Interest rates were basically at zero, so your expected return is zero,” he says. “But then at the same time, you’re in an environment where inflation is a risk and central banks are going to start increasing interest rates, so the variability of that outcome becomes really wide and uncertain.”
As a risk-focused firm, Foster says explaining this to clients has put the focus on the need for education.
“Investing in general’s an area that there’s not enough education on. When you talk about the risk side of that equation, it’s even more so. To explain it to a client, you link it back to their objectives and how certain they are of meeting those objectives.”
Foster referred to this as the “sleep at night factor”.
“If you’re not sleeping at night because of your investment risk, you’re taking too much risk,” he says. “Our job is to take as much risk as they can, but still sleep at night, maximising the returns for the risk that they’re willing to take.”
Maximising returns for clients
Return is the outcome and result of investing, but Foster says clients need to be aware that it’s not the whole process.
“That’s obviously really important, but that’s backward looking. That’s what’s already happened and you can’t change that. But where you are now is risk.”
Foster says common misconceptions, like high risk bringing high returns, and a focus on rewards over risk are important distinctions for clients to understand.
“They say past performance isn’t a good guide to future performance. That’s more or less true, but what is a good guide is risk.”
Discovering the risk tolerance in clients
As well as education, Foster says working with a client on a risk budget to determine their risk appetite helps him to help them.
“A really important role for an advisor or for a client is working out what their tolerance is, like what their starting capital is and what their objectives are, what their time frame is; are they saving for retirement and have a date in mind? Or do they have particular use of money coming up.”
Foster says there will still be some variability even when knowing the level of risk appetite.
“If you think about the likely outcomes over your investment horizon, there’s some variability about it.”
There is the expectation of a certain level of risk over time, Foster says, but that could still be over or undershot.
“That tolerance for that undershooting or overshooting, can mean that a client panics or doesn’t follow through with their investment strategy. Our approach is to minimise that variability of the outcome.”
Explaining risk to even the most discerning client is all about helping them to work with their advisers in recognising and achieving their finance goals.
“Not all risk gets rewarded, so just taking more risk doesn’t get you more return. You’ve got to be thoughtful about it,” Foster says.
The expression “don’t put all your eggs into one basket” is another way of saying concentration risk doesn’t get rewarded, Foster says.
“If you can diversify away that risk by having some other diversification portfolio, then you can achieve the same return with less risk to it.”
