There is one major theme I want to canvass over the next few months — the chain of broken promises from financial planners, research houses, investment managers and the regulators (both self-appointed and statutory).
These broken promises are inherent in the four core parts of the traditional financial planning value proposition.
The first promise says, ‘I will work with you to minimise your tax and maximise any social security entitlements’. The second says, ‘I will help you to articulate your life and financial goals and assist you to resolve any conflicts that may arise in that process’. The third says, ‘I can help you make good investment decisions that will lead to that goal achievement’. And the final proposition says, ‘I work within a fully compliant business that meets all regulatory requirements and which is centred on you as my client’.
It is my belief that none of these promises have been met and they are unlikely to be met until an industry wide agreement is reached on appropriate standards and processes for financial planning.
The consequence of not coming to this agreement is that financial planning may well revert from a putative profession to a tightly regulated arm of government.
Tax and social security are merely legislative arbitrage that can largely be systematised. They are unsustainable differentiators for a financial planning practice. The second proposition, the provision of an iterative client-centred approach has largely been empty rhetoric. The statutory and the self-appointed regulator have failed to bring their promised consumer protection to industry. Each of these promises will be more fully examined in future articles.
In this month’s article, I want to look at the complicit failure of both investment management and financial planning to deliver their promised levels of investment returns.
Three articles in the popular press on the weekend of July 19/20 all go to the very heart of the investment value proposition that planners make to their customers that says ‘your financial future will be more assured by doing business with me’.
The first article,Throw your money away: put it in a managed fund(by Alan Kohler of theFinancial Review),reviewed a recent work undertaken by John Bogle of Vanguard in the US.
Bogle’s work is a no-holds-barred attack on the benefits of actively managed funds. In essence, he argues that since 1984, active managers have:
a) underperformed the S&P 500 Index by 3 per cent per annum; and
b) that investors have actually received 6 per cent less than the managers’ reported returns — that is, the average US investor limped away with a 3 per cent return.
The explanation for this poor outcome is that investing is a zero sum game. For every winner there is a loser. The most likely losers are those with the higher costs (that is, 3 per cent per annum — half are funds management fees and half transaction costs).
The many investors who actively trade their funds and buy high and sell low (going with the market noise) achieve overall poor returns. The vast majority of US investors did not get the benefit of selecting the best active managers in the better performing asset classes at the right times. It’s hard to imagine that investor/fund manager outcomes are significantly different here.
The second article in theWeekend Australianwas less kind. Headed unemotionally,Big headed losers on the global scene, and reporting on a soon-to-be-released global survey undertaken byKPMG International, it said “global [investment] managers are egomaniacs whose inflated sense of self-worth contributed billions of dollars in investor losses over the past three years”. It echoed Churchill’s war time eulogy to the daredevil Spitfire pilots — “Never have so many lost so much in such short a time”.
The third article,Cool, Calm and CalculatedinBRWreviewed a recent Australian lecture from psychologist Daniel Kahnemann, who was last year’s recipient of the Nobel Prize for Economics.
Kahnemann challenges the basic assumption that everyone makes rational decisions to maximise their wellbeing. He has promoted the concept that irrational behaviour is a meaningful component of economic modelling. And of course, emotional reactions can lead to bad decisions. If we look at the low earning experience of US investors and apply a calm, level-headed approach to investing, we can rapidly understand his four deceptively simple recommendations to investors:
* do not trade too much;
* be diversified;
* do not trust your hunches; and
* do not look at the portfolio too often.
It’s clear that few investment managers or personal investors have followed that advice. In fact, as an industry, we have spent much of our time in recent years recommending that clients do the opposite.
For example, providing investors with real-time access to their portfolio values simply encourages them to think and act short-term. Promoting funds on the back of most recent performance is another way we teach clients to take a short-term approach.
I have never seen an ad that says: ‘We were a bottom quartile performing fund last year, but we have stuck to our investment philosophy. The assets we are invested in are under-valued. Invest with us now!’
Our managed funds are significantly more intermediated than the US. More than 90 per cent of our business is referred through a financial intermediary; where the trend has been to follow last year’s best performing asset class or top returning fund manager.
I first became aware of this trend as a young product manager watching the funds flow into the big brand names and the flavour-of-the-year investment manager. The continuing inflow to overvalued property and bond investments is evidence that little has changed.
Planners are just as likely to respond emotionally as investors and fund managers.
Brillient! reports that last year almost 80 per cent of stand-alone retail funds were churned, and in master funds, close to 40 per cent was turned over. Add these costs to the consequences for clients of managers turning over their portfolios once, twice and rumours suggest up to three times a year in some cases chasing short-term performance, and you have a recipe for low investment outcomes.
Were investors informed of the possible outcomes of churning to follow last year’s leader or chasing high reported performance figures? It is highly unlikely. It is more likely that they were told volatility will reduce over time and were given a range of income and growth projections. This is, of course, nonsense.
Churning crystallises losses, leaving the client with less to go forward with. If clients had some means to plot their investment outcomes against their goals, they might have caught on. However, most planners do not have the tools to measure investment performance, let alone compare it to any goals.
While markets performed so well, no one really cared. However, in the third year of mediocre investment outcomes, it has become a very different matter. All the ‘dazzling and baffling’ with statistics and words are no longer sufficient to convince clients that they are still doing okay. The Financial Industry Complaints Services reports it has received more complaints over the last six months than for the whole of last year.
Complaints lead to lawsuits, which in turn could well lead to ever-tightening regulations. It could lead to investment managers and financial planners co-sharing liability. It could lead to crippling professional indemnity insurance premiums. It could also lead to some clever, organised, systematised new player sweeping traditional ‘bespoke’ and institutionalised financial planning into the garbage bin, along with high priced, non-performing investment managers.
Paul Resnik is an industry provocateur—you can argue with him atpresnik@carm.com.au
