Take time to teach young in­vestors about risk, be­fore the mar­ket does

Per­sonal ex­pe­ri­ence can help re­duce po­ten­tial dam­age, Martin Pel­letier ad­vises.

Vancouver Sun - - FINANCIAL POST - Fi­nan­cial Post Martin Pel­letier, CFA is a port­fo­lio man­ager and OCIO at TriVest Wealth Coun­sel Ltd, a Cal­gar­y­based pri­vate client and in­sti­tu­tional in­vest­ment firm spe­cial­iz­ing in dis­cre­tionary risk-man­aged port­fo­lios as well as in­vest­ment au­dit and overs

When mar­kets en­ter the later stages of a bull run — as ap­pears to be hap­pen­ing now — it isn’t un­usual for in­vestors’ per­cep­tion of risk to shift, es­pe­cially when “buy the dips” be­comes a com­mon mantra and volatil­ity is be­ing com­pressed.

In our own in­ter­ac­tions over the past few months, how­ever, we’ve no­ticed that this per­cep­tion of risk varies dra­mat­i­cally de­pend­ing on de­mo­graph­ics, with those who have ex­pe­ri­enced a mar­ket cor­rec­tion or two re­main­ing a lot more cau­tious than those who have just started in­vest­ing over the past eight or nine years.

In par­tic­u­lar, the vast ma­jor­ity of older in­vestors at or near re­tire­ment age are sim­ply look­ing to gen­er­ate a rea­son­able re­turn while pro­tect­ing their cap­i­tal in­stead of try­ing to keep up with the mar­ket. While our typ­i­cal client has a high net worth and there­fore a greater abil­ity to take on risk, we’ve no­ticed that their will­ing­ness re­mains mod­er­ate de­spite all the eu­phoric head­line re­port­ing.

Given the low-rate en­vi­ron­ment, most would be sat­is­fied with gen­er­at­ing a five- to six-per-cent rate of re­turn while tak­ing on as lit­tle risk as pos­si­ble to get there. While this means hav­ing to own fewer bonds, the fear of be­ing over­ex­posed to eq­ui­ties has left some won­der­ing just what a balanced and well­diver­si­fied port­fo­lio should look like in to­day’s en­vi­ron­ment.

This out­look dif­fers sig­nif­i­cantly from that of the younger gen­er­a­tions, for whom track­ing the mar­ket has re­mained very im­por­tant. That in­cludes cap­tur­ing the gains from the tremen­dous per­for­mance in U.S. eq­uity mar­kets over the past few years as well as last year’s rally in in­ter­na­tional eq­ui­ties.

For younger in­vestors, this ap­proach has of­ten meant ea­gerly em­brac­ing the use of low-cost ex­change traded funds, even those that are a bit ex­otic in na­ture, such as those in­vest­ing in ar­ti­fi­cial in­tel­li­gence, ro­bot­ics and au­to­ma­tion, mar­i­juana and cryp­tocur­ren­cies.

In­ter­est­ingly, we’ve also no­ticed that this do-it-your­self ap­proach and high level of self­con­fi­dence has led to the de­sire to own in­di­vid­ual deals, rather than par­tic­i­pat­ing in ac­tively man­aged spe­cialty funds that of­ten have a higher fee at­tached to them.

For a fam­ily of­fice, man­ag­ing such a range of risk per­cep­tions within a sin­gle fam­ily can prove chal­leng­ing, as the next gen­er­a­tion of­ten views their par­ents’ port­fo­lio as be­ing far too con­ser­va­tive and too costly in terms of fees.

The prob­lem is that this per­cep­tion gap will not nar­row un­til this younger gen­er­a­tion ex­pe­ri­ences a mar­ket cor­rec­tion like their par­ents, who lived through the chal­lenges of record lev­els of in­fla­tion in the 1980s, the tech bub­ble burst­ing in 2000, and the 2008 fi­nan­cial cri­sis.

For­tu­nately, the man­age­ment of this wealth has not yet been tran­si­tioned down­wards and con­trol for the most part re­mains at the par­ent level.

That said, as any par­ent of a teenager knows, the best way to teach a life les­son is by let­ting them learn through per­sonal ex­pe­ri­ence while pre­par­ing in ad­vance be­hind the scenes to keep any po­ten­tial dam­age to a min­i­mum.

There­fore, we think now is a great time to teach the next gen­er­a­tion about the risk ver­sus re­turn re­la­tion­ship and a great way to be­gin is in­volv­ing them in meet­ings with the fam­ily’s wealth man­ager.

For ex­am­ple, this could mean hav­ing them par­tic­i­pate in de­riv­ing a for­mal­ized in­vest­ment process and then al­lo­cat­ing a small por­tion of the over­all port­fo­lio into riskier in­vest­ments in­clud­ing pri­vate eq­uity and debt, ven­ture cap­i­tal, and even new tech­nolo­gies.

The ideal sit­u­a­tion would be each fam­ily mem­ber learn­ing from the other and work­ing to­gether to im­prove the dy­nam­ics of the man­age­ment of the fam­ily’s wealth. For ex­am­ple, we’ve seen a lot of pos­i­tive change in the way a fam­ily’s

The ideal sit­u­a­tion would be each fam­ily mem­ber learn­ing from the other and work­ing to­gether to im­prove the dy­nam­ics of the man­age­ment of the fam­ily’s wealth.

port­fo­lio is be­ing man­aged with a com­bi­na­tion of in­sti­tu­tional ac­tive port­fo­lio man­agers, pas­sive ETFs, and risk-man­aged funds with a lit­tle ex­cite­ment added via al­ter­na­tive in­vest­ments such as new tech­nol­ogy funds and/or pri­vate eq­uity.

Fi­nally, when a cor­rec­tion hap­pens — and it even­tu­ally will — the younger gen­er­a­tion will gain the abil­ity to un­der­stand the true re­la­tion­ship be­tween risk and re­turn and know how best to pass this wis­dom along to the gen­er­a­tion be­low them.

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