The last six months have tested the mettle of the most hardened investors.
The rapid spread of Covid-19, universal lockdowns and almost unprecedented disruption to industry and the broader economy have presented challenges that have proved difficult for many people to absorb on a personal level, writes James Klempster, director, investment management, Momentum Global Investment Management.
When coupled with the highly volatile market reactions, which saw dramatic sell-offs followed by strong rallies across many markets, clients might well question what edge professional investors might have in helping them navigate these troubled waters.
After all, even seasoned fund managers will admit that they are no better placed to predict the path of this coronavirus than the next person.
Misaligned interests
Fund managers almost certainly have more data readily available than the average person on the street could ever have.
The scale of information available to professional investors is far greater than it has ever been, and although markets always have surprises up their sleeves, very few can claim to be better equipped than an experienced and well-resourced fund manager.
But does this information mean that fund managers are more able to help investors meet the requirements they have from their investments?
The answer often isn’t a resounding “yes”, and that this is due to a misalignment of interests between what asset management firms do, and clients’ needs and expectations.
Within the retail investment arena, there is a tendency to focus more on benchmarks than on client objectives. This has the potential of creating a significant mismatch between clients’ needs and the outcomes they enjoy.
To add further complications, while there may be a degree of communality among client expectations, for instance inflation-beating income for the retired or capital growth for those with future liabilities, individual requirements are frequently more nuanced and are not always best met by traditional investment strategies.
Ticket to ride
To use an analogy, if a passenger needs to travel by train to a particular town, the first consideration would be whether the train was actually heading in that direction.
The track record for punctuality or the price of the ticket are very much secondary considerations.
Similarly, the most important element of selecting investments is the potential of meeting a specific objective and not necessarily the cheapest funds or best performance relative to a benchmark.
In an increasingly sophisticated world of financial planning, where advisers can use technology such as cashflow modelling tools to help clients understand the returns which they need, I believe that benchmarks are increasingly irrelevant.
They should be replaced by measures which inform clients on how well they are progressing on their journey to their required outcome.
What clients need far more than returns derived through benchmark-driven investing, is meaningful outcomes aligned to their needs, where the fund manager is a friend on their journey instead of a slave to an index.
If I were a client who needed an annual lifetime return of 5%, I’d be immeasurably happier knowing that the manager whom I’d selected was aiming for the same outcome as me and had the potential of underpinning my financial wellness.
Cloudy skies
As we take tentative steps out of this global crisis, the shape of the economic recovery is very much uncertain.
While equity markets have staged a remarkable recovery, we have now experienced the two consecutive quarters of negative growth that constitute a technical recession.
It is likely that the coming months will see the release of a succession of negative data and gloomy outlooks.
Investors of all shades have been left reeling and a period of relative inactivity in the markets provides an opportunity for us all to take stock and reassess how we think things will go from here.
It does not take an economist’s training to predict a prolonged period of minimal growth, regardless of the level of stimulus that has been thrown at markets.
This makes the choice between benchmark-driven investing and outcomes-based investing vitally important.
Judging success
If markets generally deliver uninspiring returns over the next few years as the impact of the Covid-19 pandemic continues to reverberate around the world, what does that mean for our client who has specific and unchanged requirements from their investment portfolio?
Very much depends on how their portfolio is invested.
Funds which align to benchmarks, either performance-driven or risk-focussed, will be judged on their success in providing returns against that target.
The manager will run money as he or she always has, and the markets will do their job.
He or she may well deliver great returns relative to a peer group, but the client may still get less than they expected, and potentially far more worryingly, than they need.
Outcome-based funds are also affected by markets, but the difference is that the fund manager whose targets are aligned to client needs, has to do something different to meet them.
There is no guarantee that the outcome-based manager will perform better than the manager of the fund whose success is measured by its performance relative to a benchmark.
Nonetheless, it is surely preferable to trust clients’ investments with a manager who is incentivised to help them meet their investment objectives than to one who, while beating a peer group, still fails to deliver on client expectations.
This article was written for International Adviser by James Klempster, director, investment management at Momentum Global Investment Management.
