Being smart does not beat the market
The financial services industry is an industry which depends on the astute advice of intermediaries as they analyse and interpret market conditions in order to find the best vehicle in which their clients’ money can grow.
While this relies on the inside knowledge and years of experience of intermediaries, there are times when market conditions throws advisers a curveball, which significantly affects investments.
This is one of the biggest challenges that intermediaries need to address over the coming years. Intermediaries need to change the mind set that they can make more money in the markets based on the fact they are smarter than the competition, and market conditions.
Missing the mark
While intermediaries play an important role in the industry, and will continue to do so, we need to remember that there is always room for error and even the best intermediaries can miss warning signs given out by the industry. Some of the smartest investment minds in the world failed to anticipate the 2007 sub-prime crisis despite exponential increases in property valuations in the five years preceding it. “And even smart people are undone by market enthusiasm,” says Chris Hamman, Head of Fixed Interest Investments at Sanlam Investment Management.
It is common knowledge that investors exhibit maximum enthusiasm when markets are near their top and are most pessimistic near market low points.
Balance your emotions to find the perfect investment
It is understandable that intermediaries and fund managers get excited when the market is up and pessimistic when it is down. That is at the heart of their business. However, over reaction on either side is dangerous. Irrational behaviour could explain why investors are quick to blame fund managers for poor market performance when the fault may lie closer to home.
Hamman says there are two factors that weigh heavily on how retail and institutional investors assess their fund managers. The first factor is a short-term bias in decision making and the second factor is an unrealistic expectation on returns.
“Fund managers are expected to report on returns on a quarterly basis despite our underlying investment strategies and decisions built around five or ten year views of the market,” says Hamman. Even the principle officers and trustees of pension funds end up making decisions that affect billions of rand of retirement savings based on performance measured over these inappropriate time frames.
At a recent panel discussion at the 4th Annual African Cup of Investment Management conference, which was held in Cape Town, the panel agreed that expectations of 20% a year from products held up as risk free, were extremely difficult to manage.
One way to address such unrealistic return expectations, was for investors to rethink their view of risk. Risk should not be shrugged off as the standard deviation of an investor’s portfolio against some notional benchmark, but rather that it is a loss that will never be recovered.
Turning to regulation for answers
Other industry participants hope that regulation will improve the industry. But as pro-consumer lobbies push for greater regulation in the financial services space, there are warning signs that more regulation, just for the sake of it, is not the answer.
“The trouble with regulation is that it is backward-looking. Regulators devise safeguards against a financial crisis that took place in the past in the hope the next crisis is of a similar nature. But the complex nature of financial systems means this is highly unlikely,” says Hamman.
He adds that the reason is that global financial markets experience instantaneous change. For example, the regulatory response in the aftermath of the Enron and WorldCom scandal was to make directors legally liable for similar transgressions, but the legislation that followed, was powerless to prevent sub-prime.
“Asset managers believe that regulators have an important role to play, but want regulators to understand the difficulties they face. The desire for standardised contracts between asset managers and clients, for example, were seriously questioned because no contract or investment mandate can cover all possibilities. The debate was further complicated because long term allocations of savings in an uncertain environment, require that the risk of capital losses be weighed up against the individual saver, not having enough capital to retire on. It is obvious that if you are too short term orientated, you have a real risk of not being able to retire,” Hamman says.
The warning from the conference is that if short termism and unreasonable expectations are not addressed, investors will end up with real returns that are insufficient to achieve their savings needs.
Editor’s Thoughts:
Consumer education is a solution to the industry’s problems. The public can become more involved in investment decisions where the risk is spread between the client and the intermediary. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected].
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