As the fragile world economy begins to show signs of recovery, Ray Griffin explains how financial planners can reassure skittish clients.
This time last year, the fight-or-flight response was kicking in for hundreds of millions of people the world over as the global financial crisis (GFC) took hold.
The financial world was about to begin a precarious descent into the most sobering conditions experienced for close to 80 years.
Fear-racked investors either held the line or sold out. And while financial planners everywhere are masters of the long-term investing mantra, for many of their clients it was hollow rhetoric.
For clients of financial planners who failed to see the warning signs of the debacle that the GFC became, it is a long road back.
Portfolios over-weighted in international markets and/or heavily debt-laden companies fared far worse than portfolios constructed on well-founded research and an understanding of what was coming down the economic pipeline.
As the end of 2009 approaches it’s tempting for some to believe that a return to the good times is imminent, with investment markets bounding upwards with every piece of seemingly good news.
But economic recoveries are prone to deceptive indicators.
From sporadic upticks in US consumer confidence data to Ben Bernanke’s latest spin on America’s economic recovery, there is plenty for the ‘glass half full’ crowd to point to.
It’s now almost passé to say that the world economy is changing, but not so long ago there were few who were prepared to believe that the world’s largest economy would see the sun begin to set on it in the first decade of the 21st century.
The seeds of the US decline were not sown with the onset of the collateralised debt obligations — there were structural problems afoot at least a decade before the creation of those assets.
But in order to know this, financial services licensees and their planners needed to be open to the prospect that massive change was imminent — and that required a preparedness to accept that the past is not necessarily an accurate portent of the future.
The same applies today.
In the current US financial year, US Federal Government deficit spending is expected to top US$1.5 trillion — which will be lumped onto the now hard-core fiscal indebtedness of the last eight years since the attacks on the World Trade Centre.
The decline of the US dollar on currency markets points to growing concern about the capacity of the US government to manage the obesity of its debt obligations.
The world currency standard is now under serious threat, and numerous questions remain unanswered about the US and other economies.
For many it would be hard to imagine that interest payments might one day force the US government to its debt repayment knees, but that is something which has to be on the radar screen for portfolio constructors everywhere.
How will this affect international trade — the majority of which is denominated in US dollars?
Witness an increase in trade to China being transacted in Yuan and the overall greater bargaining power China now seems to exert when it comes to price setting — the price takers will one day be price makers.
In a related vein, which directly affects Australian financial markets, how will the developed world wean itself off the government bank deposit guarantees which forestalled runs on banks in late 2008?
Australian household debt levels are reducing modestly, but they nevertheless remain the Achilles’ heel of the economy, which, domestically, remains heavily dependent on consumption to drive growth.
However, the latest cycle of tighter monetary policy conditions dictates that consumers will have no choice but to spend less than they did leading up to the downturn.
Despite the savagery of the GFC over the last year or so the basic problems remain. The developed world remains heavily indebted, and with governments filling the breach left by the private sector in terms of spending, public sector debt (and guarantees) is being accumulated at eye-bulging levels.
And while China continues to deploy massive reserves of savings into domestic expansion — if for no other reason than to maintain social stability — at some point that must ease.
In this environment — like never before — having an eye to the future is critical to portfolio construction. How will advisers construct portfolios that have a reasonable chance of achieving what clients need?
And are all advisers professional enough to tell clients whose expectations are unrealistic that they need to modify their expectations (and thereby risk losing clients)?
On this point I’m reminded of a colleague who prepared a retirement plan for a couple which also sought the advice of a Storm Financial Group adviser.
The advice prepared by our firm was “not exciting enough” — and they have been back to seek some form of recovery advice.
These retirees are now more than a million dollars out of pocket after blowing a lifetime of work through following the atrocious Storm advice.
In the long term, conditions will be much more settled. But in 2009 ‘long term’ is much longer than at any other period in the history of personal financial planning.
Restructuring of the developed world’s balance sheet will take time.
Note that there are only three basic methods of debt reduction: increasing repayments, which in the case of government debt requires an increase in tax revenue (hardly a topic to excite Treasurers anywhere right now); selling assets and applying the proceeds to debt reduction; and finally, insolvency and asset repossession.
The key point is that all options, whether applied to the private or public sectors, have a drag effect on economic growth.
Unsolicited e-mails from financial institutions are ramping up the ‘never been a better time to go global’ line, but is that really the case?
Yes, some opportunities do exist in emerging markets — but financial planners need to resist the temptation to over-allocate to sectors in an effort to obtain a ‘quick fix’ for portfolios that are in trouble.
At some stage, every client of every financial planner will see their portfolios again retreat in value — it comes with the territory.
Many clients will be proceeding cautiously for quite some time to come, paying close attention to reports or information which run counter to their hopes and aspirations for portfolio recovery.
As always, the challenge for financial planners is to have a view to world economic conditions and the potential impact on portfolios, and then allocate accordingly.
Critically, the rationale for the position taken must be shared with clients to help them set realistic investment expectations.
These remain extraordinarily difficult and challenging conditions, and the fight-or-flight response will keep kicking in for many investors savaged by poor portfolio construction in recent years for quite some time to come.
Better portfolio planning by AFLS licensees and their planners, and taking the time to seriously contemplate economic conditions — that is, taking the time to think about what is really happening in the world economy — will only serve to better protect their clients’ financial security.
Ray Griffin is a director of Capricorn Investment Partners.
