Published on: June 28, 2012
Categories – DIY Investment
Financial advisers would need to have been sleeping under a rock for the last few years to have missed the message of management consultants exhorting them to “segment their market”. Quite so – almost the first lesson taught in Marketing courses is the importance of having a distinct service proposition for each client segment, categorised by net worth, annual income, fee tolerance, geographical proximity and a host of other factors. In practice, however, this could easily lead to an over-emphasis on the needs of the highest net worth clients, with a disproportionate neglect of those who might eventually merit greater attention. There can be no doubt that, with clients soon to enjoy greater pricing transparency, and an expectation of higher service levels, there will be an almighty scramble to secure and retain those with the most desirable qualities – broadly those having most available for investment and with not too much resistance to paying substantial annual fees.
Nice work if you can get it – and some will – but this will become increasingly crowded territory. Consumers will respond to legislative change by expecting more for their money, or alternatively paying less for the pleasure. Not before time, in the opinion of some – Dan Norman of TCF Investment observes that, “the scale of the industry has more than doubled in ten years, yet costs have risen – that is systematic failure.” So what if you are not among the privileged 5-10%, around whom future business plans are being built. Where will you be best served in the financial services arena of 2013 onwards? – not automatically by financial advisers in the opinion of this website and a growing number of other industry players.
For example, following in the footsteps of former IFAs Justin Modray (Candidmoney) and Anna Bowes (Savings-Champion), a former city banker (no, don`t log off yet) by the name of Andrew Craig has launched <plainenglishfinance.com>, a site which sets out to educate people about basic terms, such as inflation, equities and bonds. His view, according to F T Adviser, is that, “…well-educated people have no idea about stock markets or investing, so when they have surplus capital to invest, they speak to a financial adviser and, because of inherent structural flaws in the financial services industry, they get bad advice.” A mite unfair and uncompromising perhaps, but the trend is inexorably towards investors reducing their reliance on costly solutions when they might be able to get all, or at least part, of the way there adopting more of a d.i.y. investment emphasis.
Consider, for example, what has happened in the U.S.A. – so often seen as a forerunner of our business practices. Over there, “mass market investors” (as they like to call the 90-95% minority who don`t quite make it through the segmentation exercise) are attracting more and more attention from the financial planning sector. At the beginning of this month, two major players (United Capital and L.P.L Financial) set up large-scale operations specifically to dispense financial advice, via the web and telephone, to those having $25,000 to $250,000 in investable assets. These firms are different because, as distinct from merely selling products, which was the only option that had previously been available to this category of investor, they are seeking to provide holistic, goals-based planning.
Why is this relevant? In short, in the U.K. we have not yet devised a suitable solution for “mass affluent investors” (defined in the U.S. as those having investable assets of up to $1 million), let alone “mass market investors”. Interestingly, the States went through a very similar experience in 2006 to the one that U.K. investors are about to undergo - when the shift to fee-based from commission-based pricing models started to take hold. Inevitably, there will be an increasing recognition among consumers that a financial planning framework is not as difficult to construct as some of the experts would have you believe and, in order that “the glib and oily art” can be successfully challenged, there is no substitute for improved financial education.
Published on: June 15, 2012
Categories – Financial Advice
While acknowledging that justice cannot fully be done in a short blog to a subject matter which currently warrants a government-initiated review chaired by Professor John Kay, I will attempt here to leave you with a few thoughts for the weekend.
The views of John Kay are well documented: for example, urging financial institutions( in 2009) to pursue “volume growth through competitive pricing and building a long-term relationship with their customers” (Source: Financial Times). But the issue of short-termism has been around for many years and, arguably, has not been given the prominence it merits because UK plc had largely been muddling through quite nicely until recently. The economic events of the last few years, and the consequent need for more radical thinking have, however, brought this subject into sharper focus.
As long ago as 2001, Lord Myners observed that investors and fund managers were under intense pressure to maximise performance, stating: “the current quarter is what matters, perhaps the next quarter, certainly not next year`s equivalent quarter.” If anything, things have got worse, not better, since he made that pronouncement. Shareholders have reduced their investment horizons considerably, with the average holding for UK shares having declined from five years in the 1960s to less than eight months in 2008 (Source: Bank of England).
So why this greater preoccupation with short term fluctuations in share prices among investors, rather than the longer-term fundamentals of the companies in which they are investing? Some will argue it is down to the advances in technology and increased information, but I would attribute equal if not greater importance to the often self-serving influence of those advising. In short, momentum investing is more profitable for the financial institutions, as not too many end of year bonuses will be in prospect from adopting a “sit and hold” policy.
Harsh perhaps? – well no, not really, particularly when one examines the facts. Most equity investors recognise that, historically, it has been dividends that have mainly contributed to their gains from shares: in fact, James Montier of GMO calculated a couple of years ago that dividends have delivered about 80% of total returns from global stockmarkets since 1970. Yet, according to Philip Coggan (“The Economist”) quoting from a Blackrock survey in 2008, a survey of fund managers revealed that more than half of them had an investment time horizon of less than six months, while only 37% were buying shares with a view to holding them for more than twelve months – hardly too much in the way of dividends emerging from those shareholdings then. Those fund managers who turned over less than 20% of their portfolios each year earned an annual return some 1.2% higher than those turning over more than 100% of their portfolios.
Ally this to the fact that, on average, portfolio managers are believed to change jobs more than every three years (Source: Sage & Hermes) and you might end up with an impression of distinct ephemerality. Moreover, a change in fund manager invariably leads to additional transaction costs, ultimately borne by the investor.
Momentum investing causes volatility and is not in the interests of retail investors. Consider this – according to the former IMF economist, Paul Woolley, the annual turnover of British equities in 1965 was worth 10% of nominal GDP but, by 2007, this had risen to 300%. He also pointed out that the volatility of the main British and U.S. indices is some 15 – 20 times greater than the variability of the dividend stream on which prices ultimately depend. His conclusion was that, “investing based on fair value requires patience and is ill-fitted for a quarterly performance regime”.
If you are still wondering how any of this might translate to your own circumstances, I will leave you with some calculations made by Gareth Shaw of “Which” – who concluded that “short-term hyperactivity adds cost, but no clear benefit to investors.” He found that the average actively-managed fund had a Portfolio Turnover Rate of 108%, which added £258 million to its expenses. On a £10,000 investment over 25 years, growing at 5% per annum, that short-term trading cut the end value from £33,860 to £22,790.
Anyone for DIY investing?
Published on: June 8, 2012
Categories – Financial Advice
Since the credit crisis hit in 2007, followed a year later by the recession, there has been something of a sea-change in investors` attitudes towards their financial advisers. While large commercial brokerages have been seeing growth rates moving into negative territory, direct online brokerages have been enjoying a rise in their annual growth rates by almost 20%.
This appears to be a reaction, rightly or wrongly, to the perceived failure of advisers to pre-empt and shield their clients from investment losses. The implicit sentiment of, “I could have done better myself without paying all those fees” has led to hundreds of thousands more investors taking the DIY approach – probably never to return to the folds of their financial advisers.
However, it would be wrong to state that the only factor in this exodus has been client distrust of others overseeing their financial affairs. There have also been significant developments in technology which have facilitated this transition for DIY investors – including efficient platforms, round-the-clock updates and free/inexpensive research made available direct to the public.
It is of course excellent news that investors can now be empowered in this way, but only if these cost savings can be translated into tangible benefits. As Tony Batman, CEO of First Global, recently said: “Psychological factors begin to take precedence and dictate the investor`s decision-making process. Fear is an extremely powerful motivator and it leads most investors to make irrational decisions that greatly harm their ability to reap the reward of long-term investing.” The contention of traditional money managers is that, when the stock market “going gets tough”, the instinctive reaction of DIY investors is to seek loss aversion by selling their investments – invariably at the wrong time (with the benefit of hindsight).
DIY investing is an iterative process. Appropriate disciplines can be learnt and do not need to be imposed by a fee-charging third party. Over time, investors will come to recognise that sound investment practice does not involve backing tactical hunches, but rather requires a strategy of medium/long term duration. The framework is straightforward, as outlined in this website: (a) determine your appetite/capacity for risk, (b) use cash flow/life-planning software to map out your goals, (c) establish your optimum distribution of real assets, in line with your attitude to risk, (d) select inexpensive index-tracking funds to support this investment strategy, (e) phase in your investments over anything up to 24 months, (f) ensure you regularly re-balance your portfolio, in order to retain the integrity of the original asset distribution and (g) don`t lurch from one set of investments to another in search of the Holy Grail – you aren`t going to find it!
Published on: June 7, 2012
Categories – Financial Advice
In an article in today`s “F.T.Adviser”, written by the Managing Director of Yellowtail Financial Planning, Dennis Hall, it is claimed that investors perceive financial education as “a huge turn-off”. Mr Hall takes issue with the FSA`s emphasis on helping financial services clients to learn more about investing, believing the regulator is unhealthily pre-occupied with the Confucian statement: “Give a man a fish and he will eat for a day. Teach a man to fish and he will eat for a lifetime.” According to Mr Hall, having more information rarely means making better decisions.
It is an interesting piece of sophistry which, if perpetuated, would allow the cosy status quo in financial services to remain indefinitely. I, for one, take the view that ignorance does not necessarily result in bliss.
The following response was therefore made on behalf of money-guidance.com and its followers:-
“A resourceful argument, but one that is prone to flounder (sorry).
It`s a convenient and, to some extent, a self-serving view to contend that retail investors will perpetually be in a financial adviser`s thrall when, for example, online brokerages have been witnessing 19% p.a. compound growth since the credit crunch – suggesting that the writer`s representative sample may not be all that representative.
Investors may not want to get their hands dirty for haddock at £3 per pound but, when the stakes are higher (and the economy is weaker), it seems they will be more inclined to confront the enduring notion of asymmetric information which has formed the basis of many an adviser/client relationship.
In the words of Thomas Jefferson: “If you use your candle to light mine, I get light without darkening you. When I hear your idea, I gain knowledge without diminishing anything of yours”.
Let`s hope there are not too many business plans out there that are predicated on a static consumer attitude.”
Published on: June 1, 2012
Categories – Financial Advice
Some important facts that are going to change the shape of financial services in the future:-
• Using the present system of commission-based remuneration, it has to date been economic to serve customers investing as little as £13,000 (A.B.I.).
• Full service advice traditionally demands around eight billable hours (A.B.I.).
• Under the new Retail Distribution Review (R.D.R.) rules prohibiting commission, £600-£700 per client will need to be charged for current standards of financial advice, “… which is clearly beyond many customers” (F.T. 26/04/2010).
• 80% of the work carried out by 35,000 IFAs is currently based on commission (Investment Management Review, 2010).
• Post-2012, many investors who are at present served by IFAs may have to rely on themselves, their family, friends or bank for financial guidance.
• 90% of U.K./U.S. retail funds currently use active fund management, yet only 2% have managed to out-perform their benchmarks (Cass Business School).
• A recent study concluded that “buy and hold” investors did 15% better than those attempting to time markets between 1926 and 2002 (University of Michigan).
• Fees for active fund management and increased trading costs have diminished investment returns for retail consumers, while fund managers have often pursued performance bonuses through maintaining short-term positions.
• There is an increasing trend towards “momentum investing” instead of fair value.
• 1n 1965, the annual turnover of U.K. equities in actively-managed funds was equivalent to 10% of nominal GDP. By 2007, this figure had risen to 300%.
• If active fund managers turn over 100% of holdings each year, the resulting cost reduces the end value of the fund by 25% over 25 years.
• Total Expense Ratios (TERs) do not include stock turnover (76% average p.a.), research costs, taxation and entry/exit charges which, if taken into account, would push the TER of a typical U.K. All Companies Trust towards 3% p.a.
• The quoted TER of the average European equity fund is 1.91% p.a., versus 0.46% p.a. for its passive ETF counterpart (Morgan Stanley).
• Charges matter. Lowering annual costs by 2% per annum could result in a savings pot being two-thirds higher after 25 years.
• The most highly-ranked active fund managers have invariably been the biggest risk-takers, but the corollary for investors has been increased volatility.
• The volatility of the main U.K. indices is 15 to 20 times greater than the volatility of dividend streams yet, historically, more than 75% of the total return on equities has come from dividends (Paul Woolley, IMF Economist).
• The average active fund manager will retain its management team for only 2.5 years (Citywire).
• The survivorship rate of actively-managed funds is a problem. Of the 355 funds in existence in 1970, 223 no longer existed by 2006.
• Merged or liquidated funds skew performance data. In the last 11 years, 2,507 funds have been launched while 2400 have been closed or merged (F.T. 5/09/2010)
• In a recent survey of active fund managers, 50% had a time horizon of less than six months and only 36% were investing for a period of more than one year (Blackrock) – with dividends presumably being a secondary consideration.
• Index-tracking (passive) funds serve to de-risk portfolios. However, only 15-20% of financial advisers currently use, for example, Exchange Traded Funds (ETFs), as they offer no commission (Professional Adviser – 3/07/2008).
• Passive funds have historically demonstrated less volatility than active funds.
• “Transparency, simplicity and liquidity are now key for investors” (Scorpio) – but they are often still being presented with complex solutions.
• In general, the IFA sector suffers from a poor marketing and brand identity. The absence of competing market messages suggests that there is an opportunity for early mover status with an alternative service proposition.
• A significant segment of the U.K. investing public is about to be disenfranchised unless a new business model can be developed which can provide improved returns, topical information and better value for money.
The “new business model” is here – use it freely to your advantage, with my compliments.