Centralised retirement propositions are on the rise as advisers increasingly have to think about clients’ decumulation journeys.
Watch the video with FT Adviser Consumers love a new product launch. Just look at the queues outside Apple Stores when a new iPhone comes out, or the enduring popularity of car magazines with their sneak peaks of the latest models.
But launches of investment funds are different. With both of the examples I mentioned — smartphones and cars — you expect the new product to be substantially better than the last one; if it isn’t, it’s slated in the press. We already have far too many funds to choose from and, in the vast majority of cases, new funds are no better than what we already have. What they tend to be though is different to all the other funds out there, and it’s that which ensures they attract publicity. Fund management companies thrive on that publicity. They launch new products, in short, not because they will deliver better outcomes for consumers, but because they believe they will sell. A classic example is a new Aberdeen fund called the ASI HFRI-I Liquid Alternative fund, which will track an index of about 140 Europe-based hedge funds. Effectively it will give investors with at £5 million to invest access to average hedge fund returns. The fee of 30 basis points, or 0.30%, certainly seems attractive. But why would anyone seriously want to ape typical hedge fund performance? Hedge funds were all the rage in the 1990s, and some funds performed spectacularly well. Even taking into account the eye-popping fees they paid, some investors prospered. But hedge funds generally fared very badly in the global financial crisis and have failed to regain their golden touch ever since. As the Bloomberg columnist Nir Kaissar recently explained, instead of trying to make money, hedge funds “pivoted to not losing it”. “The new objective,” Kaissar wrote, “was to manage risk by protecting investors during downturns and delivering returns that are uncorrelated with the stock market. “It’s hard to imagine a lower bar, and incredibly, hedge funds failed to clear it… The equity hedge index has posted a negative one-year return 26 times since 2010, based on monthly returns, with an average decline of 4.4%.” There have been several different explanations as to why hedge fund performance has dropped off so badly over the last decade. Perhaps the most plausible one is that there is simply too much money chasing too few opportunities. You might have thought that, in view of the dismal returns that hedge funds have delivered in recent years, investors would have started to desert them. In fact the opposite has happened. According to Hedge Fund Research, the data group collaborating with Aberdeen on the ASI HFRI-I fund, assets invested in US-based hedge funds reached a record $955 billion in September 2018. With more money invested in hedge funds than ever before, your chances of beating the market over long periods are very slim. The irony is that this new Aberdeen fund may well prove very popular. Institutional investors, who traditionally like investing in hedge funds, tend to be very conservative — slow to embrace new ideas and discard old ones. Added to that, there’s still a social cachet connected to hedge funds. Also, of course, there are many investors who can’t resist a little gamble. The ASI HFRI-I fund, then, will probably be good for Aberdeen shareholders and, of course, for already very well remunerated hedge fund managers. But will it be good for those who invest in it? Relative to investing in a regular, low-cost, equity index fund, it almost certainly won’t. Whilst sound in theory, do risk-based strategies work in practice?
To find out, we took at the performance of a multi-asset Risk Parity Index and a multi-asset Minimum Volatility index. Risk Parity aims to achieve equal risk contribution from each asset class Min Volatility aims to combine each asset class to achieve a minimum variance portfolio On a rolling five year basis, both multi-asset Min Volatility and Risk Parity offered superior risk-adjusted returns relative to a 60/40 Portfolio for GBP investors. Both Min Volatility and Risk Parity offered a lower level of overall risk relative to a 60/40 portfolio. Get the full report here http://www.elstonetf.com/store/p3/Multi-Asset_Indices%3A_risk-based_strategies.html Bill Gross, one of the world’s most famous and influential money managers, has retired at the age of 74.
A specialist fixed income investor, nicknamed the Bond King, Gross is best known for co-founding Pimco Asset Management, and for managing the Pimco Total Return fund. There is no doubting his personal success. Under his leadership, Pimco became the biggest fixed investment firm in the world. Forbes estimates his personal wealth at around $1.5 billion. Gross managed to keep his investors happy for most of his career. From June 1987 to September 2014, the Pimco fund was the sector’s star performer, beating the Bloomberg Barclays US Aggregate Bond Index by around 1% a year, which for a bond manager is a large margin. But then came an unravelling. Gross was ousted by his colleagues at Pimco, who didn’t find him easy to work with, and he moved to Janus Henderson. His performance in four years there was less than stellar. He underperformed the index by some distance, and in 2018 his fund lost almost 4%. By the start of this year, it had more than halved in size to less than $1 billion — and most of that money was his own. Over his entire career, Bill Gross beat the index in more years than he was beaten by it. That might seem like a modest achievement; after all, the whole reason for paying active management fees is the hope of beating the market. Compared to his peers, however, Gross’s long-term record is very impressive. But does that really make him a star? And, more to the point, was he genuinely skilled or did he just get lucky? Distinguishing luck from skill in money management is extremely difficult. Depending on which statistician you speak to, it can take decades or even hundreds (yes, hundreds) of years of data to demonstrate skill beyond reasonable doubt. Gross certainly started bond investing at just the right time — the beginning of a bull market that lasted more than 30 years and sent prices soaring. Nearly all bond investments over that period grew in value. Gross was also a risk taker, preferring lower-quality corporate bonds to safer government bonds. Measured by annualised standard deviation, he took around 10% more risk than the index — 4.3% compared with 3.9%. The more risk a manager takes, the higher their returns are likely to be, and so it proved with Gross. There are various theories as to why his performance tailed off at Janus Henderson. The bond markets became more volatile for a start. Gross also moved away from a “total return” approach to what’s known as an “unconstrained” strategy, which may have suited him less well. Whatever the reason, Gross, like countless “star” managers before him was unable to replicate the success that had earned him that stellar status in the first place. How, then, will he be remembered? Of all the assessments made of his career in recent days, perhaps the most telling was by Gabriel Altbach, from the consultancy Asset Management Insights, in the Financial Times. “The industry owes Bill Gross a giant debt of gratitude,” said Altbach. “He made bond investing headline news and helped pave the way for countless other fund companies and portfolio managers.” Perhaps that says it all. Investing and asset management shouldn’t be headline news at all — bond investing especially. The financial media makes it far more exciting and glamorous than it really should be. It also loves characters, and Gross was certainly one of those, with his little eccentricities, his colourful investment letters and his juicy quotes. As for Pimco and Janus Henderson, Gross was their prize asset. Nothing attracts assets like a star manager, so no wonder their employers are usually only too happy to play along. Was Bill Gross genuinely skilful? We can’t be sure. Will there be another Gross? By the law of averages, probably yes. Can you, your adviser or favourite Sunday newspaper identify the next Gross in advance? Don’t even think about it. When it comes to bonds, it’s very hard to make a case for investing in anything other than a low-cost index fund or ETF.
Sectors: walking or just talking? Most portfolio managers discuss markets within the context of the economic cycle. And no wonder: the main drivers of market performance – growth, inflation and interest rates – are not constants but fluctuate with the economic cycle. Managers point to their stock selection decisions because a particular company is seen as “cyclical” or “defensive”. In theory, cyclical companies do relatively better when the economy is expanding. Defensive companies do relatively better when the economy is slowing or contracting. But despite talking the talk on sectors when analysing the economic outlook, it’s harder to judge whether or not managers are walking the walk when it comes to sector investing. If your portfolio manager is not providing a sector allocation in their reporting back, perhaps ask for one. What exactly is a sector? A sector is a group of companies which provide the same or related product or service. The most broadly use classification system is the Global Industry Classification Standard (“GICS”) which categorises companies into 11 distinct sectors. GICS further defines 69 industry types that fall within each of those sectors. Cyclical or Defensive? When a company’s earnings are dependent on or more correlated with the broader economic business cycle, they are “cyclical”. When a company’s earnings are independent of or less correlated with the broader economic business cycle, they are defensive as in theory are less impacted by downswings in the economy. The list of sectors includes sectors considered “cyclical” such as: Communication Services, Consumer Discretionary, Financials, Industrials, Materials, and Technology; and sectors considered “defensive” sectors such as: Consumer Staples, Energy, Health Care, Utilities and Real Estate. Sector indices Sector indices calculate the performance of, typically, the combined market capitalisation of each distinct sector. In this way we are able to see the performance of each sector at different stages of the economic cycle on a standalone basis, in comparison with other sectors, and relative to the overall equity market. Why use a sector lense? By looking both the economy AND the market through a sector lense it is possible to analyse how groups of companies with commonalities as regards their input (expenses) and output (revenues) behave relative to their peers to inform comparisons within each sector, and comparisons between sectors over different time frames. This helps us understand the impact the economy has on sector-specific drivers, and which sectors could be in favour or out of favour at different stages of the economic cycle. Understanding the economic cycle The economic cycle (a.k.a business cycle) is the fluctuation in economic growth rates over time as measured by real (inflation adjusted) Gross Domestic Product as measured by national statistic offices. The economic cycle can be broken down into two broad states: expansion (trend of economic growth) and recession (trend of economic decline). Expansions are measured from the trough (or bottom) of the previous economic cycle to the peak of the current cycle, while recession is measured from the peak to the trough. The economic is different from the market cycle (the fluctuation of the equity markets over time), although one can impact the other. What drives sector performance? Economic activity changes at different changes in the cycle. In periods of expansion, consumers are more likely to increase their non-essential discretionary spending – so Consumer Discretionary should do better. In periods of recession, consumers are more likely to hunker down and focus only on essential spending – so Consumer Staples and Utilities should do better, for example. This seems intuitive. Furthermore, research suggests that more specifically it is the role of monetary policy that really drives sector performance. Central Banks adapt monetary policy based on the economic cycle. When monetary policy is easing, cyclical stocks do generally better. When monetary policy is tightening, defensive stocks generally do better. Surfing the cycle Given the economic cycle and monetary policy are in flux, it follows that an investor with a strategic allocation to equities should dynamically allocate to different sectors at different stages of the cycle, rotating from cyclicals to defensives and back again as the economic cycle fluctuates. This sector rotation strategy can earn “consistent and economically significant excess return while requiring only infrequent rebalancing”. Accessing sectors All equities fall within a sector grouping. Investors must therefore decide whether they wish to construct a portfolio of stocks within each sector or have a fairly concentrated holding within each sector. For investors that want to maximise diversification within each sector, a sector ETF is a convenient way of accessing targeted and comprehensive exposures to distinct sectors. Sector investing Whether investing in a particular sector to capitalise on specific sector trends, or seeking to implement a dynamic allocation strategy between sectors over the economic cycle with an equity allocation, sector ETFs offer a low-cost and convenient way of implementing cyclical sector views efficiently and precisely. Notices and Disclaimers: Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Additional disclosure: Recently published Elston ETF Research reports “Sector Equities: 4q18 Update” and “Sector Equities: 4q18 Survey” were sponsored by State Street Global Advisors Limited. We warrant that the information in this article is presented objectively. For further information, please refer to important Notices and Disclosures please see our website www.ElstonETF.com This article has been written for a UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This article reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.ElstonETF.com Photo credit: N/A; Chart credit: Elston Consulting; Table credit: Elston Consulting In December we conducted a Survey of senior portfolio managers and decision makers from firms whose combined assets under management is in excess of £500bn. The survey was designed to get a better understanding on how those managers approach sector investing.
Our key findings based on the survey are summarised below:
Anywhere to hide? For investors with a broad mandate, asset allocation decisions between equities, alternatives, bonds and cash and equivalents gives scope to limit the impact of market volatility. But what about for mandates which necessarily must remain fully invested in equities. Within the equity sleeve, we believe a sector perspective enables investors to make nuanced adjustments to their equity portfolio. Lower volatility On a one year basis, the lowest volatility sector is Consumer Staples with a volatility of 11.6% compared to 13.3% for World Equities. Consumer Staples is nonetheless 75.1% correlated to world equities. Potential Diversifier Over the last two years, Utilities has shown both lowest beta (0.52) and lowest correlation (52.8%) to world equities. This makes the Utilities sector a potential diversifier within a portfolio context. Chasing growth? From a momentum perspective, Technology remains the strongest performing sector with an annualised return over 3 years of +20.2% (in GBP terms). Conclusion Whilst economic outlook remains key driver for sector-based performance, the current volatility and correlation characteristics of specific sectors are informative from a portfolio construction perspective. Source: Elston Research, Bloomberg. Indices used: MSCI World Index and MSCI World sector index data Notes: Volatility: annualised 260 day volatility to 31-Dec-18; Correlation: 2 year correlation of daily returns to 31-Dec-18; all data expressed in GBP terms. Notices and Disclaimers: Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Additional disclosure: The data in this article comes from an Elston ETF Research report “Sector Equities: 4q18 Update” that was sponsored by State Street Global Advisors Limited. We warrant that the information in this article is presented objectively. For further information, please refer to important Notices and Disclosures in that Report which is available on our website www.ElstonETF.com This article has been written for a UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This article reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.ElstonETF.com Photo credit: N/A; Chart credit: Elston Consulting; Table credit: Elston Consulting
John Clifton Bogle, who died recently at the age of 89, may not have been a household name in Britain, or even in his native country, the United States. But he was a true legend in the world of investing.
Better known as Jack, Bogle founded the investment company Vanguard in 1975. That same year he also introduced the first index fund for ordinary investors. They called it “Bogle’s folly” at the time, and commentators doubted it would ever take off. But Bogle stuck to his guns, and index funds eventually changed the face of investing. As for Vanguard, it’s now one of the largest investment companies in the world, with $5 trillion under management. Jack Bogle could have been one of the wealthiest people on the planet. But he chose a mutual ownership structure for Vanguard, which instead of enriching shareholders, drove down costs for investors. Millions of people are considerably better off today than they would have been without him. Bloomberg estimates that, over the last 45 years, Bogle has saved Vanguard investors $175 billion in fees. Add to that the money he saved for customers of other firms that lowered their fees to compete with Vanguard, and the total must run into trillions. To quote the financial blogger Morgan Housel, Bogle is the biggest undercover philanthropist of all time. But perhaps Jack Bogle’s biggest legacy is his intellectual honesty. He told investors the truth — that low-cost index funds are the best way for most of us to invest. In The Little Book of Common Sense Investing, he wrote: “Simply buy the entire stock market. Then get out of the casino and stay out. “This investment philosophy,” he went on, “is not only simple and elegant. The arithmetic on which it is based is irrefutable.” Bogle is perhaps best known as an advocate of low-cost passive investing. “The iron rule of the financial markets,” he once said, “is reversion to the mean.” Simply by the law of averages, there will always be active fund managers who have outperformed the market in the short term. But, over the long term, only a tiny fraction of them are able to beat it after you factor in the costs of using them. Yet Bogle also liked to remind people that fees and charges aren’t the only reason why investors fail to achieve their goals. They are often undone, he warned, by their emotions and by acting on impulse. Investors, he said, need to put their emotions to one side, have rational expectations for future returns, and avoid changing their strategy in response to market noise. Jack Bogle’s honesty and professional integrity didn’t exactly endear him to Wall Street. In one of his later books, Enough, he wrote: “On balance, the financial system subtracts value from society.” But, towards the end of his life he repeatedly expressed a hope that things will change, and that the financial industry will one day become a profession. “No matter what career you choose,” he urged readers of Enough, “do your best to hold high its traditional professional values, in which serving the client is always the highest priority.” Bogle then quoted the English Quaker William Penn, founder of Pennsylvania, the state he loved and lived in: “We pass through this world but once, so do now any good you can do, and show now any kindness you can show, for we shall not pass this way again.” Jack Bogle may have gone, but his legacy lives on. He truly was the man who changed investing for good. In this report, we look at the recent risk-return performance for a broad range of asset class exposures for GBP-based investors, as represented by our selected indices for each exposure.
The objective of the report is to show the historic 1 year and 3 years risk-return characteristics of the investment opportunity set available to multi-asset investors when constructing portfolios. Get the full report here The absence of a clearly defined plan for Brexit is creating damaging uncertainty for businesses and the markets.
Leaving the EU, but remaining in the EEA through EFTA would address the concerns of the majority of Referendum voters, whilst also requiring a spirit of compromise from both sides. Joining EFTA would immediately provide the UK with continued free trade within the EU/EEA, a more valuable set of external Free Trade Agreements, and the added flexibility to negotiate its own free trade deals bilaterally. Setting a timetable for re-joining EFTA provides a straightforward solution that will give the necessary confidence and direction to businesses and the markets whilst respecting the outcome of the EU Referendum. This paper, drafted for but not published by the Centre for Policy Studies in July 2016, sets out the rationale for Britain in EFTA or "BREFTA" and calls for greater engagement with the "C10": the largest ten Commonwealth economies. The broker and fund platform Hargreaves Lansdown has just brought out a list of recommended funds called the Wealth 50, which has received plenty of attention in the financial media.
HL used to have a larger list, the Wealth 150, but the list been gradually shrinking. The number of funds has been whittled down further and there are now 60 of them. The company says that the funds have been selected after quantitative and qualitative analysis by its in-house research team. It has also negotiated lower charges for its clients. Wealth 50 clients will save, on average, 30% on ongoing charges, with the cheapest actively managed fund carrying an annual charge of 0.22%. We lead such busy lives that when we’re offered a short cut, something that saves us time and effort, we generally like to take it, and that’s precisely why companies such as Hargreaves Lansdown produce these sorts of lists. But are recommended fund lists, or buy lists as they’re sometimes known, really of any benefit to investors? Research by the Financial Conduct Authority, showed they can be very misleading. In its interim report on its study into competition in the asset management industry, the FCA reported that most funds on these lists fail to beat the market and that firms that publish them are often biased towards their “own brand” funds. We shouldn’t be surprised. Academic research has consistently shown that, in the long term, only a tiny fraction of funds outperform the market on a cost- and risk-adjusted basis. Dr David Blake form Cass Business Buisness School puts the figure at around 1%. What’s more, he says, future outperformers are impossible to identify in advance. The difficulty of identifying future star managers ex ante was highlighted in a paper published last summer, Investment Consultants’ Claims About Their Own Performance: What Lies Beneath?. It was authored by Tim Jenkinson and Howard Jones from the University of Oxford’s Saïd Business School, Jose Vicente Martinez of the University of Connecticut and Gordon Cookson from the FCA. The researchers looked at the performance of funds recommended by investment consultants between 2006 and 2015. Once fees were factored in, they discovered, the funds that consultants didn’t recommend subsequently delivered better performance than those they did recommend. We simply don’t know how long the 60 funds on the Wealth 50 will remain on the list for, let alone what sort of returns the funds will deliver in the future. No one can systematically pick winning funds in advance, and that includes Hargreaves Lansdown. The bottom line is that recommended fund lists are not meant for your benefit at all. They’re essential a marketing gimmick which helps brokers and platforms to generate revenue. HL is a very successful business, which has profited from a trend towards individual investors taking more control of their retirement savings. Since 2015 it has grown its active client base by 50% and its assets under management by 70%. But its offering isn’t cheap. On top of annual fund charges and the on-going transaction costs that funds incur, HL clients also pay a platform charge of 0.45%. That may not sound like much, but the compounding effect of paying that charge year after year has a significant impact on long-term returns. Don’t be tempted, then, to choose from this or any other recommended fund list. They really are best ignored. The phenomenal rise in ETF adoption looks extraordinary. But viewed in the context of any technology upgrade – from tape to CD, from CD to MP3 – there’s nothing outstanding about it. It’s just common sense.
ETFs are just a more flexible and lower cost way of getting exposure to an asset class relative to traditional mutual funds. Whilst some vested interests in the active world murmur about “How might ETFs cope in market distress?” The answer is, repeatedly (including in recent market turmoil), “Just fine, thank you”. Born out of crisis Indeed, the massive switch from Mutual Funds to ETFs is in part a direct result of the Global Financial Crisis. In the GFC, some investors were caught out by 1) not knowing exactly what was in their fund and 2) not being able to sell funds they no longer wanted to manage their risk exposure because they were “gated”. We’ve seen similar gatings of property funds after the Brexit vote, and of bond funds in face of interest rate rises. The two greatest benefits of ETFs are, in my view, their transparency (knowing exactly what’s inside the fund on a daily basis, and how it’s likely to behave) and their liquidity (there’s a secondary market in ETFs via the exchange, which means you can buy or sell an ETF without necessarily triggering a creation/redemption process within the fund). Transparency enables a more precise way of accessing specific asset class exposures. Liquidity is not just about intra-day trading, it’s more about the simple fact that if you don’t want to hold a fund anymore, rather than relying on the goodwill of the manager to accept your redemption order, you can simply sell it on via the exchange. This simple difference is a key advantage of ETFs. Secondary market Take the high yield bond market. So in a rising rate environment, if investors wish to sell high yield bonds, with mutual funds the manager has to sell the underlying investments (putting further pressure on price and liquidity), with ETFs, the manager can simply sell the ETF to another participant willing to come in at a level that is a bargain for both. The underlying investments need not necessarily be sold. Liquidity is only ultimately as good as the underlying asset class. But in every bond market jitter (including last week’s) bond ETFs have continued to function, and enabled liquidity. I prefer to turn the question on its head: what product do you know of (aside from a mutual fund) that you can only sell back to its vendor? I’m struggling for examples: just a quick look on eBay is enough to show that there’s a secondary market in pretty much everything, be it vintage newspapers, matchbox cars or antique furniture. A quick look on the London Stock Exchange, shows there’s a market for pretty much every type of fund: global equity, UK value, UK gilts of different maturity buckets, corporate bonds of different investment grades, gold, commodities, property: you name it, you’ll find it. It’s asset allocation that counts Furthermore, I’ve never bought the argument that “ETFs only work in a bull market”. Sure equity ETFs do well in a bull market, but there are ETFs for each asset class that could be in favour at different stages of the cycle. ETFs are a portfolio construction tool to reflect a desired asset allocation. If you only want high quality, dividend paying equities, there are dual-screened income/quality ETFs. If you don’t want equity exposure, there are bond ETFs. If you don’t want long-duration bonds, there are short-duration bond ETFs. If you want a cash proxy with a bit more yield, there are Ultrashort Duration Bond ETFs. So ETFs don’t perform better or worse at different times in the cycle. Managers can perform better or worse by getting their asset allocation right. ETFs are just a straightforward way of managing a multi-asset portfolio. From closet index to true index ETFs are by definition the commoditisation of mutual fund industry (standardised formats that can be bought and sold at a published price). The plethora of index rules are the systemisation of investment process: whether you’re philosophy is traditional (cap-weighted), momentum, value, small cap, income, or quality there are now indices for most investment styles for most asset classes in most regions. The investor’s toolkit has got smarter, cheaper and more flexible. What’s not to like? Given the large number of closet index funds out there, we can expect a continued switch from closet index to true index to drive ETF adoption yet higher. In the meantime, if anyone knows of an eBay for old mutual fund holdings – please let me know. Global stocks have been on something of a rollercoaster ride just lately, with markets trading at, or near, a two-year low. Doubtless many investors, especially those who are close to retirement, are feeling fearful. Fear is a hugely powerful emotion. It makes us do irrational things, and the sad fact is that, in the context of investing, there’s no shortage of people who want to take advantage. The Californian financial adviser and blogger Robert Seawright wrote an excellent article on this subject the other day. “When the markets are roiling,” he wrote, “fear is pitched all day, every day, and human nature buys it. And pays a premium. A very big premium.” “Fear makes money,” says Daniel Gardner in his book The Science of Fear. “The countless companies and consultants in the business of protecting the fearful from whatever they may fear know it only too well. The more fear, the better the sales.” So, what’s the answer, apart from steering well clear of salespeople? First things first: don’t feed the fear. When behavioural finance expert Greg Davies was invited on to Bloomberg to talk about the market rout in 2008, he was asked, live on air, what should investors if they’re really worried. “They should stop watching Bloomberg for a start,” he replied. Apparently, they tend not to invite him now. But, more importantly, investors who are anxious need to do some reading and arm themselves with an understanding of the bigger picture. To do it properly, it’s going to take you a little while. If you don’t have time, you could just watch a short video just released by Dimensional Fund Advisors, on how markets reward investors who stay disciplined at times such as these. The video is presented by DFA’s Vice-President and Head of Advisor Communication, Jake DeKinder. In the video, Jake says this: "Recent events have increased the feeling of uncertainty and may have led some to question whether to not to make changes to their investment approach. "It’s important to remember that while these events might seem frightening in the moment, they are not necessarily unique or unusual. “Throughout history capital markets have rewarded investors who are able to stay disciplined. After many major events, financial markets have recovered and delivered positive returns.” So what sort of events is Jake referring to? Well, here’s a series of graphs showing how a balanced portfolio comprising 60% equities and 40% bonds fared in the one, three and five years following the last six major market downturns: What these graphs show very clearly is that those who stayed invested while so many others didn’t were amply rewarded on each occasion.
Here’s Jake DeKinder again: "Over the long term, investors who have been able to remain patient and tune out the short-term noise surrounding these events have been rewarded for doing so. “In the face of uncertainty, it’s important to remember this historical perspective, and focus on the things we can control, rather than the things we can’t.” If you’re in any doubt about what, if anything you should be doing, you should seek the help of a financial adviser. Otherwise, take Jake DeKinder’s advice: tune out the noise, think long term and disregard anything that’s out of your control. And most of all, fear not. Christmas is costly enough without baling out of the stock market. Here’s the Dimensional video: Dimensional Fund Advisors: Markets reward discipline
Elston's Henry Cobbe, Head of Research discusses ETF trends on Bloomberg ETF IQ programme.
Watch the Video It’s almost that time of year when thoughts turn to resolutions for the 12 months ahead. Financial resolutions are always among the most common and, according to a poll by YouGov, the most popular resolutions in the UK this time last year included reading new books and learning a new skill.
For 2019, how about aiming to improve your knowledge of investing and personal finance through reading? No, we’re not talking about articles and blog posts, which only give you a tiny snapshot, but actual books which will leave you feeling that you’ve genuinely broadened your understanding. If that appeals, here are seven books we would recommend. THE BIGGER PICTURE The Geometry of Wealth: How to Shape a Life of Money and Meaning by Brian Portnoy Most people embark on an investment strategy without having a plan, and it’s not a good idea. True wealth, explains Brian Portnoy, is “funded contentment”. So, first of all, you need to work out what contentment looks like for you. What do you want from life? How much money do you need to enable you to lead that life? And when are you going to need it? Tackling these big questions and tending to everyday financial decisions, says Portnoy, are complementary, not separate, tasks. His book will help you to find the answers. The Financial Wellbeing Book by Chris Budd Personal wellbeing has almost become a new religion, but there are very few books that specifically tackle the financial aspect of it. In this book, former financial planner Chris Budd picks up on many of the issues discussed in The Geometry of Wealth. The starting point, he says is to “know thyself”. He then goes on to explain the secret to feeling in control of your finances, being able to cope with a financial shock and ensuring you always have options — and the peace of mind that goes with each of those. INVESTING The Little Book of Common Sense Investing by Jack Bogle Jack Bogle is the founder of Vanguard Asset Management, and the world’s most prominent advocate of low-cost index funds. This short, best-selling classic explains, in simple terms, how to guarantee your fair share of stock market returns by simply tracking global markets at minimal cost. The tenth anniversary edition has been updated and revised and is personally endorsed by none other than Warren Buffett. How to Invest with Exchange-Traded Funds (ETFs): A practical guide for the modern investor by Henry Cobbe & Shweta Agarwal OK, we’re not entirely impartial — Henry Cobbe is, of course, Elston Consulting’s Head of Research. But this book will particularly suit those who are looking to manage their own investments. It explains how to diversified and manage a low-cost, diversified and robust portfolio constructed entirely with ETFs. The Four Pillars of Investing by William Bernstein Learn about investing in just three books? Are we serious? Yes, we are. To quote William Bernstein in The Four Pillars of investing, “the body of knowledge that the individual investor, or even the professional, needs to master is pitifully small.” Bernstein’s book is a superbly written, down-to-earth and easy-to-read explanation of how to design an effective investment strategy and how to construct and manage an investment portfolio that reflects your personal capacity for risk. FINANCIAL HISTORY The Ascent of Money: A Financial History of the World by Niall Ferguson Uh? Why do you need to know about history to be financially savvy? Well, it’s true that history doesn’t repeat itself exactly, but having a very long-term perspective helps you to understand how financial markets work. “Sooner or later, says Niall Ferguson, “every bubble bursts (and) greed turns to fear.” But the good news is that capitalism has proved remarkably resilient over the centuries and, for patient investors, equities have delivered strong returns compared to cash and bonds. PSYCHOLOGY Thinking Fast and Slow by Daniel Kahneman What? How does a knowledge of psychology make you more financially literate? The answer is that, as the legendary investor Benjamin Graham once said, “the investor's chief problem – and even his worst enemy – is likely to be himself.” As Nobel laureate Daniel Kahneman explains, our minds are tripped up by error and prejudice, and investors are a classic example. His book includes a wealth of wisdom, as well as practical techniques for improving the decision-making process. Book lists are, of course, subjective. Books that we find helpful might not do the trick for you. Let us know how you get on with these, and if you have any suggestions for books we should add to future lists, we would love to hear from you. All sorts of possible cures have been suggested for the ills of active fund management. Cutting fees is surely the most obvious solution if the industry wants to stem the flow of assets out of actively managed funds. Simply trading less frequently would probably make a difference too.
One of the arguments we frequently hear is that the answer lies in higher conviction, or “real” active management. It’s certainly true that the widespread practice of closet index tracking — charging active fees for effectively hugging the benchmark — is a big problem for the industry. As well as being fundamentally dishonest, it almost guarantees that, after costs, the investor will underperform a comparable index fund. “Real” active managers, on the other hand, genuinely try to beat the market by investing in a smaller number of stocks which they believe will outperform. Over the long term, only a tiny proportion of active managers outperform the market on a cost- and risk-adjusted basis — David Blake from Cass Business School puts the figure at around 1%. One thing those very few winners have in common, the evidence shows, is that they tend to be high-conviction managers with relatively concentrated portfolios. Understandably, then, the high-conviction approach is being heralded by some as the answer to the overwhelming failure of active managers to outperform. But is it? For a start, a manager can can have high conviction and yet be completely wrong. Deviating from the index doesn’t mean you’ll see better returns than the market; it means you can expect different returns, which could either be better or worse. New research by Tim Edwards and Craig Lazzara at S&P Dow Jones Indices suggests that far from solving active management’s problems, moving towards portfolios with fewer holdings may well exacerbate them. In a paper entitled Fooled by Conviction, Edwards and Lazzara suggest four likely consequences of active portfolios becoming substantially more concentrated, none of which makes comfortable reading for active investors. Likely Consequence No. 1: Volatility will probably increase Portfolios with a large number of holdings are less volatile than those with small number of holdings. So, for instance, if a manager reduces the number of stocks they hold from 100 to 20, the portfolio’s volatility will almost certainly increase. Likely Consequence No. 2: Manager skill will be harder to identify It’s already extremely hard to distinguish luck from skill in active management. Think of each stock pick as an opportunity for a manager to demonstrate their skill. The fewer stocks they pick, the bigger the impact that luck is likely to have on the outcome. Likely Consequence No. 3: Trading costs will rise There are two reasons, Edwards and Lazzara argue, why costs would probably rise with greater concentration. First, fund turnover would increase. Secondly, transaction costs per trade would also rise, because trading a higher percentage of the outstanding float in a security typically incurs a greater percentage cost. Likely Consequence No. 4: The probability of underperformance will increase Stock returns, in technical parlance, are naturally skewed to the right; in other words, the average stock tends to outperform the median. After all, a stock can only go down by 100%, but it can appreciate by more than that. Logically, then, portfolios containing fewer stocks will tend to underperform those with more stocks, because larger portfolios are more likely to include some of the relatively small number of stocks that elevate the average return. Conclusion So, what can we conclude from the Edwards and Lazzara paper? As the authors note, skilful managers sometimes underperform, and those who lack skill will sometimes outperform. “The challenge for an asset owner,” they conclude, “is to distinguish genuine skill from good luck. The challenge for a manager with genuine skill is to demonstrate that skill to his clients. The challenge for a manager without genuine skill is to obscure his inadequacy. Concentrated portfolios will make the first two tasks harder and the third easier.” Remember, S&P Dow Jones Indices is not a disinterested party in the debate about the rival merits of active and passive investing. It makes its money from licensing its indices for fund managers to use, and therefore has a vested interest in promoting passive strategies. That said, this latest paper is a valuable contribution to the discussion and one which gives advocates of higher concentration in particular plenty to think about.
What, one wonders, would Alfred Cowles III have made of the current “debate” about active and passive investing?
Cowles was born in 1891, the son of one of the founders of the Chicago Tribune. He became a successful businessman, but his true passions were economics and statistics. One question in particular exercised his mind — can the professionals predict the stock market? — and in 1927 he set out to find the answer. Over a period of four-and-a-half years, Cowles collected information on the equity investments made by the big financial institutions of the day as well as on the recommendations of market forecasters in the media. There were no index funds at the time, but he compared the performance of both the professionals and the forecasters with the returns delivered by the Dow Jones Industrial Average. His findings were published in 1933 in the journal Econometrica, in a paper entitled Can Stock Market Forecasters Forecast? The financial institutions, he found, produced returns that were 1.20% a year worse than the DJIA; the media forecasters trailed the index by a massive 4% a year. “A review of these tests,” he concluded, “indicates that the most successful records are little, if any, better than what might be expected to result from pure chance.” 11 years later, in 1944, Cowles published a larger study, based on nearly 7,000 market forecasts over a period of more than 15 years years. In it he concluded once again that there was no evidence to support the ability of professional forecasters to predict future market movements. What is so extraordinary about Alfred Cowles’ work, and the techniques he used, is how ahead of his time he was. Cowles was the first person to measure the performance of market forecasters empirically. Even among students of academic finance, the common perception is that it wasn’t until the mid-1970s that the value of active money management was seriously called into question, most famously by Paul Samuelson and Charles Ellis. In fact it was Cowles, more than 30 years previously, who first provided data to show that it was, to use Ellis’ phrase, a loser’s game. So why wasn’t Cowles’ research more widely known about? Why did it take until 1975 for the first retail index fund to be launched? And why is active management still the dominant mode of investing even now, in 2018? There are probably many reasons. The power of the industry lobby and the large advertising budgets at the disposal of the major fund houses have undoubtedly played a part, as has the growth of the financial media. But it was Alfred Cowles himself who put his finger on arguably the biggest factor behind the enduring appeal of active management. Late in life, Cowles was interviewed about his research into market forecasters. In Peter Bernstein’s 1992 book, Capital Ideas: The Improbable Origins of Wall Street, he is quoted as saying this: “Even if I did my negative surveys every five years, or others continued them when I’m gone, it wouldn’t matter. People are still going to subscribe to these services. They want to believe that somebody really knows. A world in which nobody really knows can be frightening.” Cowles’ prediction has proved to be spot on. Both active management and market forecasting are far bigger industries than they were when he died in 1984. Investors, it seems, still want to believe that the market can be beaten, despite all the evidence that no more fund managers succeed in doing it than is consistent with random chance. |
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