This is hardly surprising given what investors went through in 2007/08/09 and even though equity markets have risen considerably since then they are still loathed to chase returns at all costs just in case the world turns upside down.
No lessons from history
The traditional asset allocation answer used to be to invest in fixed income for protection and equities for returns but gilts returning 15% on the one hand and cash in a bank losing you money on the other are proof enough of how traditional asset class risk profiles are upside down.
As an aside, I am bored witless reading about supposed risk-free assets and safe havens as there aren’t any.
Anyway… private client investors still want everything; they are risk averse but still want the equity upside. The question they are asking at the moment is, now that equity markets have rallied, hitting record highs in many cases, is: “Are fund managers protecting capital at the expense of generating returns?”
Given the events of the past five years with 50%+ bull markets and, as Glyn Owen, investment director at Momentum Global Investment Management, describes “unforeseen events that have terrified people”, there has been a great deal of emphasis on risk.
But he is just starting to see signs of change, citing the increase in biotech IPOs and covenant-lite loans coming back.
“It is all to do with the drive for income and the danger is that people are buying assets that are not compatible with their long-term outlook,” he added.
I would argue that the question is actually being asked of the wrong group as the answer should come from the portfolio manager, the asset allocator, the individual client’s wealth manager and not the fund manager.
As long as the latter group are able to communicate what returns they are aiming for and what risks they are taking, then the skill is in blending the funds and securities across all the asset classes available.
The problem that portfolio managers have today is the increase in asset class correlation that makes it even harder to do their job as asset allocators.
Pre-crisis: Low correlation – May 2007
Current: High correlation – April 2012
Source: HSBC; Bloomberg. Based on 80-day window
In an interview for the next (June) issue of Portfolio Adviser, Hasley Investment Management’s multi-strategy portfolio manager, Richard Philbin, said: “The opportunity for active managers over passive managers is going to be absolutely huge in my opinion over the next five to ten years, in both returns and the risk of those returns.
“Now is very much the time for active managers to put their head above the parapet and say they have protected assets for the past few years but the momentum is now good for equities.”
What investors actually want is control and a degree of certainty, for both the level of returns as well as management of risk.
The way Philbin, for example, manages this in his portfolios is to look at the suitability of a particular fund when working in combination with other funds across 19 different asset classes. His emphasis is on what returns he can generate within given ranges of volatility.
For the full interview, read Asset Allocator in June’s issue of Portfolio Adviser that will hit your desk on 4 June.
Owen argues in a similar vein, saying that investors need to go beyond the broad asset categories.
He says: “Instead of government bonds, look at corporate bonds, inflation-linked bonds, bank loans, convertibles and across the geographies. Relatively speaking there is some value, but in absolute terms yields across the fixed income piece are still very low.
“In equities, look at different styles so not just growth or value but momentum, quality stocks, income payers etc.”
True diversification is incredibly difficult to find because there is, broadly speaking, little value in fixed income, equities are expensive, property is illiquid and commodities do not generate that much-needed income and their valuations are sentiment-driven.
So, are fund managers protecting capital at the expense of generating returns? They probably are, and are for very good reasons.
But I still think the onus is even more on the portfolio managers to do something about it, and with suitability at the heart of the matter, as brought to us by RDR, we are closing in on the answer.
