Black Monday 1987 – Learning from disaster

The Black Monday emergency of 1987 exposed all sorts of problems within the investment management sector, says Sue Whitbread. But 30 years on, the use of DFMs and multi-asset funds has helped create the evolution of the new investment landscape

The 19th October 2017 marked the 30th anniversary of ‘Black Monday’ – the stock market crash when the S&P 500 index lost 20.5% of its value and the FTSE 100 lost 10.8% in just one day – something which has not been seen since. From a historical perspective, of course, it’s easy to focus solely on these negative figures – but we often forget that the UK market still managed to generate a positive return over the year. More to the point, the markets learned valuable lessons about crisis management which have had a profound effect on how we do things today.

Happy birthday

The fateful crash began in the morning in highly-leveraged Hong Kong, and then followed the clock around the globe to Europe and of course to London (where a hurricane had just knocked out part of the power supply, which didn’t exactly help matters.) By the time the tsunami hit the United States, many of the world’s major markets had already declined by a significant margin and counter-party risk was spreading panic and alarm: Hong Kong, for instance, didn’t reopen for almost a week.

The story we all remember about 1987 is that the system was savaged by computerised programme trading patterns which stampeded this way and that and which quickly created havoc. We also forget that there were no automatic circuit-breakers, which would nowadays shut down a market if it moved too much in a day. So the damage on that fateful day was potentially uncontrolled.

But that was then, and this is now. We know that circuit-breakers work, because they saved Shanghai twice during New Year 2016 alone.  And although the past thirty years have given us the dotcom bubble and the global financial crisis – which have shown us that things can still go badly wrong when risk taking and sentiment gets somewhat carried away – the changes for the better have been striking.

Don’t look back in anger

We could start, for instance, by looking at how the financial advice profession was structured in 1987. Those readers who are old enough to remember will recall an industry where individuals could begin advising clients with no prior qualifications, or even training. The process revolved around the sale of products, some offering the sellers eye-wateringly high levels of commission. The range of investment funds was far more limited than it is today, and the use of managed funds within single premium bonds was a relatively standard approach.

Fast forward, then, to today, where greater professionalism, competition and transparency have transformed the business of advice. Clients’ needs are put firmly at the heart of the process, with products seen as tools to enable the delivery of a service which adds real value for the client.

Advisers are required to meet the exacting treating customers fairly (TCF) requirements, and to comply with every speck of the the Retail Distribution Review (RDR).  They must ensure that they are putting their clients’ needs first, and that they consider as wide a range of investment options as possible in order to meet client risk and investment objectives.

That need to spread investment risk, coupled with the low interest rate environment in which it is hard to get returns on cash, has been touted as some of the reasons behind the increased focus on diversified strategies.

Diversification, transparency and cost

Making sure that clients benefit from having a well-diversified, balanced investment portfolio is of course crucial if advisers are to minimise the impact of market volatility and focus on the long term benefits which such diversification brings.  There is no news here, of course. But transparency is also a critical factor these days. And so, of course, is cost.

Advisers are very aware how the underlying costs of investment impacts upon long term returns. And so, increasingly, are clients. Hardly a week goes by when the consumer financial press isn’t reporting on this very topic. That’s one of the reasons why there has been such a notable increase in advisers’ use of passive investments such as ETFs, as part of the drive to reduce the overall cost burden on client assets under management. Together with investment trusts, which can combine active diversification with reasonable cost, the drive reflects a growing focus on the overall impact of fees and charges – something that is likely to gain more momentum in the months and years to come, as investment groups compete with the likes of Vanguard to bring costs down.

Investment management – what’s your approach?

There are many different ways that advisory firms can integrate the investment management process. This is a crucial decision for each individual firm to determine which option, or combination of options, works best for them.

Many advisory businesses will keep the portfolio management service in house, therefore offering a “one stop shop” service to clients. For some, this extends to having full discretionary management permissions or for others using best-buy lists might be preferred, with investment operating on an advisory basis.

Whichever in-house approach is used, the responsibility for operation and compliance rests firmly with the business itself.  This subject we will be covering in detail in future editions. For now, we will look at some of the outsourced options which are open to advisers.

Working with a DFM

Of the advisers who outsource the investment function, many of these are opting to work with discretionary fund managers (DFM).

DFMs generally provide two main types of solution to advisers – bespoke solutions and model portfolios. With bespoke portfolios, the portfolio can be designed to meet clients’ specific needs and circumstances. Model portfolios will typically have a lower cost and will usually consist of a range of fairly standard portfolios with a range of different risk profiles.

Each DFM will have their own approach, their own processes and procedures to ensure that they can meet their overall objectives.    We’ve asked Gavin Haynes, who heads up the day to day management of Whitechurch’s Discretionary Fund Management services, to give us some insight into the key rules which are employed within his team. You can read Gavin’s summary of the golden rules of investment management HERE 

Multi-asset funds

Another popular way to diversify and spread risk, of course, is though multi-asset funds, a rather broad term which may cover a multitude of possibilities. The term describes funds which invest across several asset classes (traditionally equities, bonds and cash), but it may also mean spreading between many fund managers who may favour a range of different styles, strategies, sectors and regions.  Ultimately, multi-asset managers strive for consistency, creating the potential for capital growth as well as income in some cases, and it allows for the conditions where the better performers may offset the poor performers.

Multi-assets bring diversification of course, particularly for smaller investors who are not in a position to benefit from some of the more bespoke options.  When market valuations are high, as they are at present, a well-balanced multi approach can produce compelling risk-adjusted returns which can prove beneficial and very popular with advisers and clients alike.  Another appeal is that multis are viewed as being a lower risk option than pure equity funds, but with greater potential for growth than a fund which invests purely in bonds.

But what goes on behind the scenes within a multi-asset fund manager? We’ve asked Barry Widdows to share his insight into how the process works within the multi- asset team at Prudential Portfolio Management Group. You can read “A day in the life of a multi-asset porfolio manager” HERE 

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