Data shows that many investors have responded by taking on more risk in order to maintain their lifestyles. When clients deviate from their own risk profile, this virtually always ends in tears. Some advisers have successfully been warning clients against this whilst also actively responding to new areas of opportunity such as the increased interest in emerging and Asian bonds. With a reasonable outlook for many Asian or emerging currencies and economies we continue to favour this asset class, although the unwary need to look out for spread blowout risk on longer durations.
Stay vigilant
The recent proliferation of defined or target returns may seem to be the perfect solution but in many cases this could turn out to be the worst solution of all. Almost every week there are new double digit return investment opportunities. Vulnerable advisors need to be especially vigilant not to be seduced by flash sales pitches, expensive brochures, promised returns and extra commissions in today’s low yield environment
Sadly the quality of these offerings isn’t always as impressive as the sheer quantity of them. Despite the compelling cases put forward by persuasive fund marketing materials, in many cases the underlying assets themselves are questionable. Even if the underlying assets do pass muster, invariably the structure of the fund is simply unfit for purpose. Whatever the merits of the latest open-ended life settlement/traded endowment/litigation funding/student accommodation/property/forestry/private equity/etc etc investment offering, a fundamental mismatch exists between the asset and the structure.
Treasury bills are the archetypal fixed income assets because they have an issue price, a fixed income payment and a guaranteed maturity value. To pretend that the income stream or maturity value of the various asset classes above can be sliced and diced robustly into an issue price, a maturity price and a coupon (even if automatically re-invested) is nonsense.
The Arch Cru or Glanmore fiascos should have shown the need for investment structures to be fit for purpose.
Commercial properties should be in listed closed-end vehicles, such as REITs whose price reflects the immediately realizable value of the underlying asset and which don’t magically go up at 8% every year irrespective of the market.
Direct holdings of forestry offers tax breaks to UK residents who may be willing to hold direct ownership of UK woodland for 20 years and whose value in the interim should probably be treated as not much more than zero. But clients wanting assets that can be realized or even valued every day can only get that through liquid publicly-listed forestry stocks like Plum Creek Timber.
Fiction
The fatuous argument that because these funds are sold to medium term investors, mark to model accounting merely acts as a smoothing mechanism over the cycle is tantamount to saying that all investors in such funds need to abandon commercial reality and live in a mark to model accounting bubble. Taking this view, continuing to invest into or hold assets such as the property fund launched in 2006 that has gone up in a straight line by almost 50% since launch compared to a benchmark of equivalent properties which is down by 25%, would seem a sound investment strategy.
The only difference to be seen between the fund and the benchmark is that the fund uses mark to model pricing whereas much of the benchmark doesn’t. Assuming that the benchmark is accurate (if anything it’s likely to be slightly overstated by the growing amount of mark to model pricing out there) investors buying into or holding this fund are actually paying £2 for every £1 of asset value just for the privilege of being able to maintain the fiction of mark to model pricing for a little longer before it goes horribly wrong.
Advisers need to focus on providing the strong guidance that clients really need to make tough decisions in such a challenging investing environment, steering investors away from the fantasy yields of mark to model.
