Born-again-Keynesian Martin Wolf recently posed the question “is there any point in saving?” to a surprised audience, which included me.
The evidence he presented was not that surprising: unless an investor is prepared to accept a reasonable level of risk to capital, there is no real rate of return to be found.
This means investing a significant percentage of a client’s portfolio in equities, which are handsomely priced for the return on risk. This is not about taking short-term tactical investment decisions; these are long-term global trends. “We’d be better off encouraging people to spend it,” he said.
Risk as a concept has been under the microscope since late 2008 but some still view it as a linear process, with every decision revolving around “attitude” to risk. How about approaching it from a different angle?
Let’s assume everyone saving has an investment objective in mind. It probably requires some “real” rate of return to beat inflation after charges and so on. Let’s say that means a 50 per cent investment in equities.
Looking at some typical attitude to risk mapped portfolios that means an average attitude to risk, compared to the norm, right down the middle at five out of 10. Having looked at the statistics on attitude to risk profiling results, about 50 per cent of those profiled have an attitude to risk which will achieve no real rate of return on an investment portfolio mapped to it.
In many cases they are being invested into those portfolios because they map to their behavioural attitude to risk. We should also remember there are those who are taking on more risk than they need to achieve their objectives.
The primacy of objectives
If we treat the client’s attitude as just another piece of information to help the adviser and give primacy to the client’s objectives instead it can drive a different outcome. To achieve a particular investment objective it may be absolutely necessary to accept greater volatility in order to reduce the risk of not achieving that goal. Note the word “risk” is applied to the likelihood of outcome not to attitude, product or fund.
Capacity for loss is a more objective test than the purely subjective deeply ingrained behaviour brought out within an attitude to risk but tough choices await. Volatility is an almost inevitable function of inflation-beating saving. Insuring against it is expensive but solutions offering this will no doubt proliferate because of demand.
Recommending a portfolio that is more volatile and with a greater capital risk than a client’s attitude suggests clearly raises the potential for complaint. At the same time it is likely, however, that such an approach is entirely correct. Doing the right thing, it appears, requires the adviser to wear some risk also.
Am I playing down the importance of attitude to risk profiling? Absolutely not. Understanding your client will be not be instinctively comfortable experiencing volatility when this is their only hope of achieving their goal is crucial in managing and coaching them through it. It is an incredibly valuable tool. But serving up a portfolio based purely on behavioural needs, which most likely will not hit the objective investment targets set, is not right either and simply defers the problem.
The job of the adviser
Much of what I have written over recent months has focused on the importance of establishing clear objectives, which allow recommendations and results to be measured. When investment returns were good, it was easy to get away with vague “saving for the long term” objectives. That is just not possible in the current economic climate and it will not be ever again.
The good news for advisers is that those who merrily make investment decisions based on their attitude to risk, with no expert advice or counselling to navigate around these issues, will undoubtedly become unstuck.
Adding a risk profiling tool to a self-directed investor website sounds obvious but could be disastrous for some. Conversely, I am informed one auto-enrolment scheme’s default “balanced” investment option has an 85 per cent equity exposure, which is certainly taking this particular bull very bravely by the horns.
The greatest impediment to successful investment is often quoted as investor behaviour; it just takes a long time to prove it. Whether it is dealing with pension freedom queries, writing a report or explaining the difference between volatility and risk, managing client behaviours to make sure they reach their goals is the difference between getting advice and investing direct.
Phil Young is managing director of Threesixty