The tools available to recognise potential returns as well as identify risks are getting more sophisticated but what they are being applied to has not changed either – they still have access to the same asset classes, with more alternative assets being introduced every few years, but the underlyings do not change at all.
Yet the gap between the outcome they want from their investment and the investments they choose to deliver this is getting wider.
Individual and institutional investors are matching, say, a cautious strategy with what is defined for them as a cautious fund or portfolio when what they actually need to satisfy their investment objectives is something considerably more aggressive.
This is because, according to The Influential Investor: How Investor Behavior is Redefining Performance, a report from the Center for Applied Research think-tank, they are more aware of economic factors (i.e. scared by them) as well as what it describes as “deeply misaligned interests among many participants” including providers and intermediaries, asset owners and managers, and governments, regulators and politicians.
The less than good news (but not quite bad news) is the report’s conclusion that “the current benchmark model does not speak to the needs of the investor. Relative performance based on peer groups or indices may serve the provider, but the investor’s view of value is more complex and reflects their own personal blend of alpha seeking, beta generation, downside protection, liability management and income management.”
And my favourite line: “In the future, the investor will be the benchmark.”
The good news is that much of this is being answered – “misaligned interest” in part by RDR and various other FSA and Brussels-based regulations; the move to the investor being the benchmark is coming through risk-rating both the investor and the funds they invest in.
Investors are still driven by performance but more and more it is an absolute return, benchmark-free performance that they are looking for rather than beating a benchmark or an index; those who are looking for alpha are by and large willing to pay for it; the vast majority are doing so within a framework of downside protection.
Getting to the position where investors’ goals are the ultimate benchmark is going to take time but it looks like we are going in the right direction.
One move that would speed this up would be to reduce the number of funds available by introducing a type of promotion and relegation – or even better a method of comparing funds which gets rid of the consistently rubbish ones once and for all. A topic for another day…