By the time a new fund is up and running, the investment environment or premise that justified its proposed use in portfolios may have already changed.
However, it is more likely because most product manufacturers are primarily driven to produce what investors are seen to be demanding at the time, rather than what is necessarily good for them.
While this approach is understandable from a commercial perspective of a fund manager, it is arguably not the best approach for the financial planning industry, which aims to be a ‘profession’, but also directs most of the industry’s fund flows.
A ‘professional’ is supposed to advise clients what they need in their portfolio, not react to the latest popular fad. This does not mean planners should close their mind to new opportunities. Discerning this difference is vital.
Of course, we also must heed the fundamental lessons of behavioural finance — and the crucial (and rather obvious) one is that investors value avoiding losses more than twice as much as they value profits.
Time and time again the industry has given clients poorly diversified and excessively risky investment portfolios that went against this fundamental premise and leading many to bail out when times got tough.
Excessive exposure to equity funds in 1987, unlisted property funds in 1990, bond and capital stable funds in 1993, and global equities in 2001 are obvious examples.
A more recent example is property securities funds. Neglected in the late 1990s, the money has poured in over the last couple of years given their good performance and a growing belief that they were the perfect defensive asset.
The number and size of funds grew significantly and one fund manager even came out with a geared property securities fund several months ago.
This occurred just as the sector began its worst period of underperformance for several years, at a time when the trusts themselves had already lifted gearing, and long-term interest rates were vulnerable to a rise.
While this particular fund may still end up delivering for investors in the long-term, the question is whether it was really developed with investors’ needs in mind.
Perhaps smaller company funds are heading in a similar direction. Smaller company funds have once again become the flavour of the month, with some funds up 30 to 40 per cent in the last few months and a rash of new products hitting the market.
While I do believe a long-term bias towards smaller companies in portfolios makes sense, there are times, such as now, when I believe this bias should be tempered. At the very least, deciding now is the time to load up on small cap fund exposure for clients that currently have none is questionable.
However, planners are clearly under pressure with new products and some fund managers are aggressively promoting the recent performance of these funds.
So what is the big product trend now? It would have to be capital guaranteed and protected investments, no doubt reacting to the poor returns of the last few years (and the three to six months time delay in getting such products off the ground).
The industry has recently launched a series of such products, including a capital guaranteed technology fund and capital guaranteed equities funds.
The providers of such products justify their launch with such comments as, “We’ve listened to people saying they want stable returns and to be able to profit from volatility” or “the real emerging theme for investors in the current environment is for capital preservation”. Doesn’t this mean we are letting the patients prescribe their own medicine?
Don’t get me wrong here. I do believe capital guaranteed funds can sometimes play a role, but in my view they should never be the main game for a profession trying to secure individuals’ long-term financial futures.
Given their additional cost and the ability of properly diversified portfolios to offer exposure to most of the same underlying assets with modest portfolio risk, they rarely make sense from a strict investment perspective.
Where they can sometimes make sense at a practical level is where some investors would simply refuse to get exposure to a certain asset area unless it is offered in a ‘protected’ form.
Hedge funds and managed futures are one example. If the only way we can convince certain investors to invest in some areas that otherwise make sense in a portfolio is by providing some protection, then maybe this is still a reasonable solution. Perhaps not optimal, but probably better than no exposure at all.
Technology funds in the late 1990s were perhaps the most striking example of the industry producing funds to feed current client demand.
Clearly, the investment rationale for these funds was close to non-existent, as they simply leveraged up exposure clients already had. Most were highly speculative and should have been flagged as such.
An examination of gold equities funds is quite relevant in this discussion. After all, they have done very well in the last two years (although this is coming out of a 20-year bear market).
I have been publicly positive on the role of gold in portfolios for a number of years and am not jumping on the bandwagon because, at present, there are no unlisted gold equities funds available. In fact, the last one actually closed to new investors in 2001, just as the gold bull market was emerging.
This and the minimal exposure of most equity funds and client portfolios to gold is indicative of the enormous scepticism about gold’s role in a portfolio that suggests to us that gold’s bull market is still early on in climbing up the ‘wall of worry’.
As one commentator put it recently, “there is no gold bandwagon yet, but the train is leaving the station”.
Further, at least with gold, there is a very strong diversification case for including it in portfolios, despite its inherent volatility. The numbers show that global gold equities (as measured by the FTSE Gold Index) actually have a negative correlation with world equities.
There was no diversification case with technology funds — they were simply highly correlated but leveraged versions of something to which most investors already had significant exposure.
I know of one major asset manager that has been considering the launch of a gold fund for some time. However, their view was they could not do so until they were sure the major research houses would support it.
While advisers do need support for their product recommendations, the need to ‘know your product’ has never required that funds be rated highly by the major research houses.
Planners should rightly be sceptical of new fund offerings given fund managers’ track record of offering the wrong funds at the wrong time. However, they should not be so sceptical as to discard every new idea without any rational or considered assessment.
Rather, they should be encouraging the industry to think about its provision of funds in the context of clients’ total portfolios. Not because clients say they want it today, but because it makes sense in a properly diversified portfolio.
Dominic McCormick is chief investment officer withSelect Asset Management .
