The financial planner has a tough task. Top among these is to manage client expectations while simultaneously navigating the volatility of investment returns, avoiding the industry obsession with short-term performance numbers and maintaining strong enough equity exposure to generate real returns.When you manage someone else's money you must make sure they understand that they will not get rich quick,says Candice Paine, Head of Retail at Sanlam Investment Management (SIM).Your goal is to avoid the risk of losing capital as well as ensure that the available capital withstands the ravages of inflation.She was taking part in an investment panel discussion held at the 2012 Annual Financial Planners Institute (FPI) Convention in Johannesburg, 19 to 21 July 2012.
Asset managers favour asset allocation, the mix of assets between cash, bonds and equities, as the most sensible tool to ensure inflation beating portfolio returns. But how much of your clients capital should be allocated to each asset class.This question is typically answered by considering historical performance data over long periods of time. An assessment of South African asset class returns going back 100-years suggests that equities are your best bet, delivering 7% real (after inflation) returns over the latest decade. The long-term return from listed property, a hybrid of bonds and equities, is around 6% real. And cash brings up the rear for most time frames.It is clear that to grow your clients' capital, particularly if they need to draw an income, you cannot leave them sitting in cash,? said Paine. The solution is to construct a portfolio comprising various asset classes with 10-year weighted average real returns of inflation plus (say) 5%.
Another stab at the active versus passive debate
SIM adds alpha (return above the benchmark) by relying on active fund managers who have the ability and persistence to outperform over multiple periods. At present the CPI plus 5% benchmark can be achieved with an allocation to equities (55%), listed properties (15%) and bonds (5%) with the balance in cash or near cash investments. There is always a temptation to take a heavier equity weighting, but asset managers have to protect against the downside risk that higher equity volatility exposes them to. If you were 100% invested in equities through the 2008 market collapse, your clients' capital would have been entirely wiped out.
Gavin Wood, chief investment officer at Kagiso Asset Management agrees that a higher weighting to equity is the only sensible way to provide real return.Equity is the only asset class that gives you a return that reliably beats inflation,he said. It is the top performing asset class relative to bonds and cash.Another plus is that the value of individual companies, the shares in an equity portfolio, offer reasonably stable value, while the stock market is a proxy for the real economy through its link to business profits and GDP growth. Share market volatility is largely a result of varying expectations of corporate results and prevailing investor sentiment.
One of the biggest debates in the asset management space is whether so-called active management strategies where fund managers make active decisions on the shares and investments within that fund delivers better returns for investors than passive strategies, where a benchmark is bought.There is a place for active and passive management,said Paine.You can rely on a constructed portfolio provided you manage your clientsexpectations.
It is not always about performance
Woods observed that over the past eight years only a handful of fund managers had out performed the All Share index. The common thread among these managers is that they focus on valuations when selecting shares.Investors need equity to avoid inflations erosion and to grow capital in real terms, he concluded.Active managers can outperform after fees by focusing on valuations buying and holding shares when prices are low and selling and avoiding shares when prices are high.
Understanding client risk profiles
There is a risk in obsessing over investment returns. The toughest lesson the industry needs to learn is to drop its infatuation with small numbers, reckons Anne Cabot-Alletzhauser, head of Alexander Forbes research institute.We have allowed our industry to be governed by the law of small numbers and cavalierly ignored how much noise there is in performance data,she said.It clouds what we are actually looking at.Unfortunately financial planners face a dilemma in that they cannot wait around to determine whether an idea or fund manager philosophy really works. The solution is for planners to do their homework, rely on their intellect and ask questions when considering survey results or presentations.
The best way to tackle the performance dilemma is to remember that the greatest value financial planners offer their clients is in financial coaching.Your clients want you to get them into the market and deliver the risk premium you so often talk about,concluded Cabot-Alletzhauser.
Editor's thoughts: There is no shortage of short-term data against which to measure active fund manager performance.Unfortunately much of this data is meaningless reflecting the ebb and flow of markets and investor sentiment rather than the skill level of the asset manager in question. The value in active management and, for that matter most investment methodologies, exhibits over much longer periods. Do you still scan the one, three and five-year performance numbers before investing your client in the apparently best performing unit trust fund.