When it comes to portfolio management solutions, Brian Tora asks whether today’s greater choice of investment options is necessarily a good thing for advisers and portfolio managers or whether it comes with strings attached?
I have remarked before when writing this column, as to how different managing money for private investors is today compared with when I first started in this business. Half a century ago the options available were strictly limited. Not that there were many people to look after in those days. It is estimated that there were perhaps as few as a quarter of a million individuals owning shares in the middle of the 1960s, but even so they controlled more than half the market.
Greater choice, greater complexity
Contrast that with today when the investing institutions dominate share ownership, despite the fact that there are now several million investors in the stock market in this country. While the whole business of investment management has become more professional over the years, it hasn’t necessarily made it any easier. For a start, mistakes are punished swiftly these days. Moreover, the range of options available to portfolio managers has become alarmingly wide, not just in terms of asset classes, but also in the manner in which these assets are managed.
I recall some research which was conducted not long after I joined the private clients’ department of a leading firm of stockbrokers some 53 years ago. It suggested that the optimum number of shares to be included in a portfolio was eight, on the basis that performance volatility did not fall sufficiently fast after this number to justify the additional effort of monitoring more companies. I doubt even a high conviction investor would risk limiting his or her portfolio in such a condensed fashion today.
As for the availability of investment assets that lack correlation with each other, such is the extent of their availability that it should be possible to create a portfolio to meet any level of risk demanded by the underlying client. Not that this always works, of course, I recall the collapse of Long-Term Capital Management more than twenty years ago. A hedge fund with a few Nobel Laureates contributing to the investment process, it discovered that there was more correlation between its underlying assets than it could cope with in difficult market conditions.
Hedge funds and property are two asset classes that were only available to the seriously wealthy until comparatively recently. New investment opportunities have sprung up, like infrastructure, venture capital and private equity, while bonds now play a much more important part in portfolio construction than used to be the case. Absolute return funds have proliferated, though as one wily commentator once remarked, sometimes they deliver absolutely no return. And on the international front the degree of segmentation is truly amazing. You can even buy a fund investing in music royalties. Spoilt for choice? You bet we are.
Uncertainty brings complications
Yet the task of assembling an appropriate array of assets when the outlook is so obscure on a number of fronts is as difficult as ever. Take the recent situation, which I must acknowledge could well have been overtaken by events by the time you read this. Political chaos ruled at home, with the nation more divided than at any time I can remember. And America is just as split, with next year’s Presidential election bringing out the worst in the participants.
Trade wars continue on a variety of fronts and the geo-political outlook has seldom looked as unappetising since the end of the cold war, always assuming you do not subscribe to the view that a new cold war has been in place ever since Putin took up the reins in the Kremlin. The cauldron that is the Middle East continues to raise alarms and no resolution to North Korea or Afghanistan can be spotted. It makes you wonder why investors are not more nervous than they are.
While there are indeed options to diversify portfolios to provide a hedge against many of these uncertainties, the reality is that most investors and their advisers are very conservative in their approach and prefer to stick with investments they understand. There is nothing inherently wrong in taking this line. Indeed, in many ways it should be lauded. When an investor – or more particularly his or her adviser – buys or recommends an investment that is not truly understood, you can expect problems.
In the past I have acted as a professional witness in cases usually brought by an investor against an adviser that has landed them with a big, unacceptable loss. One such case involved the purchase of a fund that invested in somewhat esoteric assets in the US. I was working for the law firm representing the adviser’s professional indemnity insurance. The fund represented a large proportion of the investor’s worth and had imploded. Cut and dried, you might think, but this was a complex case which involved greed on the part of the investor and a lack of appreciation of the risks involved on the adviser’s part.
The outcome is immaterial, but the lesson is clear. If you do not understand how the investment’s return is generated, then steer well clear. The same applies if you cannot evaluate the likely risks inherent. It is for this latter reason that I never became a Name at Lloyds, though I accept the risks are far better defined these days. But in difficult times like those in which we live, diversification is a requirement. Happy portfolio construction everyone.
Brian Tora is a consultant to investment managers, JM Finn.