The continued market volatility and global instability may be leaving some investors anxious, and questioning how current market conditions affect their returns. Some clients may be delaying making investment decisions and could be missing out on valuable time in the market. So, could smoothed funds be the solution for clients seeking a calmer investment experience?
In times of volatility, clients may feel tempted to react emotionally to protect their investments or may even wish to delay making any investment decisions until volatility has calmed. It’s easy to understand why clients may react this way, but these snap decisions (although founded in the human need to avoid loss) may prevent them from reaching their long-term goals.
Smoothed funds – too complex?
Smoothed funds have often been overlooked due to their complexity, especially with varying methods of smoothing available in the market. Often, they can seem difficult for clients to understand, making them harder to recommend.
However, there are simple smoothing mechanisms available that make explaining smoothing to clients easy. They can help provide confidence and comfort that the clients’ funds won’t see the same sharp market fluctuations they might see in an unsmoothed investment, encouraging them to remain composed – and invested – for the long term.
Different routes
There are different smoothing mechanisms within the sector. LV=, for example, offer a smoothing mechanism that is based on what’s happened rather than what might happen. The smoothing mechanism takes a rolling average of a fund’s daily unit price over the past 6 months (or 26 weeks) to produce a ‘smoothed’ average fund price*. This mechanism aims to reduce the stress of stock market investing and sudden shocks and cliff-edge falls in investment performance.
A blend of uncorrelated smoothed funds, which react differently in different markets, could be one route to further reducing volatility of an overall portfolio.
Which type of client would they suit?
Smoothed funds are particularly suited to risk-sensitive clients with a lower composure for loss, be that due to their proximity to retirement or their attitude to risk overall. The smoothed sector can offer some respite from the typical ups and downs of equity investing and combat the natural human tendency for loss aversion.
If you have clients in need of comfort who are looking to shelter themselves from sudden market shocks, smoothed funds may be the ideal solution.
Why are smoothed funds needed?
Fluctuating markets are to be expected, and investment returns are impacted by many factors including periods of economic and market uncertainty. We have already seen this many times, most recently during the Covid pandemic that hit the world in 2020 and left markets in turmoil due to the sudden lockdowns that spread across the globe, with stock markets seeing extreme falls. Between the end of January 2020 and mid-March, the average loss in the ABI Mixed Investment 40-85% sector was over -17.5%.
The European Debt crisis, that started in 2009 as a result of the financial crisis in 2008, is another example of how markets react in uncertain times. Smoothed funds were not immune to the market downturn, but whilst markets experienced significant volatility for the rest of the year, LV’s smoothed funds continued to provide a low volatility, smoothed experience for their investors.
Over 2022, there was poor investment performance across a wide range of asset classes. Human instinct at times like this can be to not only stop investing further but also to encash assets to avoid further losses, when the ability stay composed and remain invested is far more likely to give long term benefit. Time in the market versus timing the market – as the saying goes. But it doesn’t have to be a simple one fund solution. For those customers more concerned about loss than potential gain, using a blend of approaches may be a better way to maintain that composure. For example, using annuity income to provide a guaranteed income stream alongside a smoothed asset to dampen the impact of volatility and potentially other assets to drive further growth can be a way to really tailor an approach for an individual client’s circumstances
So, for advisers who haven’t yet considered the opportunities smoothed funds could offer, and with the instability we’re now facing in the market once again, now could be a fitting time to discuss these as a solution for those risk-sensitive clients.
Kirsty Wright, Head of Wealth Proposition at LV=.
*Smoothing can be suspended at our discretion. This may be in exceptional conditions or if the underlying price was 80% or less of the averaged price. If smoothing was suspended the funds may need to be valued using the underlying price. For some funds, we also have discretion to use a daily gradual averaged price with an appropriate smoothing period of up to 26 weeks.
