WHAT SHOULD YOUR ADVISER BE DOING?
Nothing – if they did it right the first time, writes Maya Fisher-French
An adviser should ensure that any investment portfolio matches your long-term risk and return requirements right from the start, and should therefore not be switching due to the volatility inherent in equity investments.
Carol Axten, CEO of wealth manager WellsFaber, says the key role of a financial planner is to educate clients at the start of the relationship about what they can expect from their portfolio and how to manage the emotional side of investing.
“We show clients that they are invested for the long term and that what may today seem like a big event is really a tiny event in the greater scheme of things,” says Axten, who adds that they have not had any clients phoning to switch their portfolios as they understand the investment strategy.
“Unfortunately, some advisers feel that they need to make changes to justify their advice fee, but the advice fee is for the research and analysis that goes into creating the plan and selecting the right investments, as well as the ongoing relationship. We don’t have to switch to show value,” says Axten, who is also concerned about investors or advisers who switch because a fund is underperforming in the short term.
“It’s easy to get caught up in the panic and sell out of an underperforming fund, but then you miss out when the style or investment strategy of the fund manager pays off.”
This idea of “chasing fund manager returns” can actually make us poorer. Investors tend to chase past returns, so unit trusts that have performed well over the past year receive massive inflows, while those whose returns have dipped see outflows.
Carl Lategan, head of independent financial adviser distribution at Allan Gray, argues that it is precisely this behaviour that is the biggest culprit in wealth destruction.
“Time and again, we see investors disinvest when performance dips and then they come back when performance improves. The issue is that they don’t benefit from the uptick because they usually respond after the unit trust has done well. An important part of the value of an investment is destroyed by this behaviour – trying to time the market results in investors buying high and selling low, which means that investor returns are often lower than the returns of the unit trusts in which they invest.”
To illustrate how this behaviour affects returns, Allan Gray analysed investor behaviour over the past two years regarding its Allan Gray Balanced Fund. Keep in mind that the rationale behind investing in a balanced fund is to protect your investment against the more dramatic market movements in a pure equity fund, as a balanced fund also invests in cash and bonds.
Investors who remained in the fund for the full two years, despite a fall in performance between January and November last year, would have had a total return of 20.12% over the two years. However, due to the underperformance of the fund relative to the market during that period, the fund saw significant outflows. Yet the majority of these outflows occurred mostly after the underperformance and at a time when the fund was actually recovering; those investors lost out on about a 6% outperformance of the market by the fund.
This is because we react to past performance and not future potential.
Perfect science would have us investing just as the fund performance recovers and we’d switch to another fund just as the fund is underperforming. The problem is that such perfect science does not exist and the cost implications of changing funds can only eat further into your potential returns.
As US writer and independent financial adviser Carl Richard says: “Investing based on past performance is like driving while looking in the rear-view mirror … It leads to a lot of accidents!”