Collins: Flogging equities or flogging a dead horse?

In my last article I said that “this industry for as long as I can remember has all been about flogging equities”.

The logical extension of this is that advisers are equity salespersons. If you need proof of this you need look no further than the Financial Services Reform Act (FSRA) that defines advice in terms of product advice, while product is defined (in the main) as equity investments. So, if an adviser’s role is to sell equities, then recent times are really challenging some of the industry’s basic tenets.

However, before I explore these tenets, the more alert of you may have noticed I referred to advisers and not financial planners. This is because FSR does not really regulate financial planning, unless you believe financial planning is only about product (equities) advice and implementation (dealing).

Many people in our industry don’t miss a chance to bag real estate agents, especially the marketers and the ‘white shoe brigade’. We are critical of their sharp practices, the selling of over-priced properties and the secret commissions. Real estate agents will argue that you can never lose money buying property, and the way to make ‘real money’ is to negatively gear. Investment properties are good for both income and capital growth, even some tax free and tax deferred income.

Obviously, such practices and promises are an anthema to anyone in the financial services industry. We would never recommend any over-priced assets, nor would we fail to disclose any marketing support or soft dollar arrangements. No one ever loses money with shares (er, over the longer term), especially those investors with margin loans. And any tax-effective scheme we recommend is always firstly a sound investment proposition. Gee, I’m glad we are different to those terrible real estate agents.

Back to equities. Recently I had the pleasure again of listening to Peter Thornhill being passionate about equities. No one could be more passionate about equities than Peter. He talks about value versus price and income versus growth. He gets you to again believe in the fundamental value of equities. But in doing so, he challenges the industry’s way of viewing equities and how they should be used. He was especially critical of how equities are being used in allocated pensions.

Now, I don’t pretend to be an investment (equities) expert, but for the last 20 years at least I have listened to and watched countless powerpoint presentations from so-called experts. Also, and more importantly, I’ve been a client of a financial planner for the last six or seven years. And, I nearly forgot, I have also completed the Diploma of Financial Planning.

In that time I’ve had drummed into me: modern portfolio theory (not too modern now); the differences between strategic asset allocation and tactical asset allocation; attribution analysis; dollar cost averaging, etc, etc. I’ve been shown pretty graphs and charts — I can’t wait for the next snail trails chart. I’m provided with all this ‘you-beaut’ software that can calculate returns to 15 decimal places. All of this tries to convince me that investing in equities is a science.

But is it?

If it is, why doesn’t it act rationally (scientifically); why did so few (if any) not predict the market downturn over the last few years? Why are there as many views about the future as there are economists? (Personally, I believe economics should be taught in the history faculty.)

Notwithstanding Peter’s arguments, I’ve struggled to understand why advisers (should I say financial planners) have this unquestioning belief in equities. Is it because they really believe they provide the best return to advisers over time? Or is it because they are part of an industry (and regulatory environment) that is built around the promotion of equities? (Remember, real estate agents are part of an industry that is built around the promotion of property.)

Are advisers just the final cog in the equities distribution chain? The chain starts with the investment analysts who work for the investment banks/stockbrokers who promote — sorry, provide research — to fund managers. The fund managers then promote their funds to the research houses, dealers and advisers. The research houses then rate the various fund managers. Each of these players is selling product, and they want to sell the product, irrespective of its price.

The virtues of dollar cost averaging are extolled. Nice examples are shown of how it works in both a rising and falling market, but always for an accumulator. To this, add the promotion of margin lending, irrespective of whether the market is rising or falling.

When has a manager ever said, “I’m not going to raise any more money because the market is over-priced” (sorry Peter — over-valued)? More importantly, when has a research house ever announced that the market is over-valued and that no money should go into equities? Never, because all have an unerring faith in the market — it will always go up, it is just a matter of time. (It’s a good thing that the Japanese have a lot of patience.)

This all pervading marketing machine is ever ready with arguments which explain and justify what happens and why, and why we should continue to have faith in the market. What I can’t follow is that on one hand, we are told that equites are long-term investments so we should sit and hold. However, on the other hand, we are told that equities are volatile and therefore need to be reviewed regularly.

Is the reason I don’t follow this because I don’t ‘get’ the business model? Although equities are for the longer term, they are both complex and volatile, thus the need for initial and ongoing advice. Equities sit most easily inside a collective investment structure (managed fund). This structure provides an easy mechanism for initial and ongoing fees to be charged and paid. And platforms have now made the same charging and collecting mechanism available for listed securities.

But given recent times (markets and publicity), will advisers be able to continue as equity salespersons, or will clients demand more? Will the client wake-up to the fancy charts and graphs and see them for what they are — just a view of history? Dollar cost averaging is working in reverse in allocated pensions in the current falling market — not a pretty picture. When will the client get sick of excuses and more empty promises?

I believe in equities, but like everything else in life, they should be used in moderation.

Maybe modern portfolio theory is just that — a theory. If it’s good enough for Robert Maple-Brown to sell equities and sit in cash from time-to-time, maybe it’s good enough for the investor.

The fund manager may want to sell product all the time, the margin lender may want to lend all the time, the research house may have a range of fancy model portfolios, but who is the adviser supposed to represent?

By being an equity salesperson, is the adviser really representing the client?