Good advisers can help protect in turbulent times
Investors often tend to overreact
One of the more important lessons I’ve l earned managing money is that extreme market conditions feed into human emotion and investor behaviour. During market corrections, investors can’t hit the sell button quick enough, for fear of further losses and during market rallies they can’t buy fast enough, for fear of missing out on further gains.
A good adviser protects the investor against thems elves in s uch environments, but unfortunately many end up compounding the problem.
Low- risk investments are recommended at market bottoms and higher- risk investments are sold to clients at market tops — otherwise known as return chasing.
Interestingly, advisers are now dumping their high-fee mutual funds at a record pace and switching to lowcost ETFs for their clients.
The reason is not to necessarily improve performance and lower fees, but to protect advisers’ margins, which will be exposed when new rules governing what information must be disclosed to clients come into force in the next few months.
In the end the client will see their fees go down a bit, the adviser gets paid the same, and the mutual fund company and their portfolio managers (whether inhouse or external) are cut out of the picture.
Then along come the robo- advisers, who are saying “why not cut out the adviser altogether” and they’ ll do the asset allocation and ETF selection for you at a fraction of the cost.
But with all of this cutting, we wonder if investors are truly better off — does it actually deal with the problem of return chasing?
Not necessarily so, especially in today’s frothy market environment.
In the adviser’s case, instead of marketing those funds with strong near-term returns many are simply substituting t hose ETFs with similar high- return profiles.
More so, they could be taking on even more risk for their clients at the wrong time by switching into market- tracking or high beta ETFs trading at their highs.
Such ETFs may do little if nothing to protect their client’s portfolio during a correction and will track it to the downside dollar-for-dollar depending on its correlation with the market.
The damage could even be more catastrophic in the event that an ETF was selected based solely on its recent performance.
While a robo- adviser can make a lot more sense than hiring a broker or adviser, as one should not be paying a large fee for someone to manage their passive portfolio, try holding the hand of a high beta algorithm during a correction and asking for it for advice on what you should do.
That said, we think passive strategies work very well when positioning a portfolio after a correction, as one does not know which sector or stock will recover first. Owning the entire market is a very prudent course of action, in that case.
This also i sn’ t to say there are not great advisers out there that utilize both funds and ETFs for a very reasonable combined fee. For example, high net worth investors can often get top notch service at some of the institutional firms directly or investment counselling platforms including both bank and non-bank owned.
The first thing they will do is create an investment policy outlining your risk tolerances and identify corresponding strategies that will be updated at l east yearly for any changes in personal circumstances and to reflect the overall market environment.
Importantly, such strategies will not be motivated by preserving their profitability margins but instead focused on what is in the best interest of the client.
This could mean owning more passive ETF strategies during market l ows and switching to more active and risk- managed strategies through institutional pooled funds during market highs and/or a combination of both.