Brexit – Now What?

The UK woke up on Friday morning to a vote to leave the EU, the Prime Minister is set to leave office in October and the markets are suffering a bout of jitters.  We all knew that these were possibilities.  To some this is a good day, to others it is not.  But we are where we are and we need to look forward to where we go from here.

We should not, however, lose sight of the fact that what we have witnessed is a long-standing, robust and stable democracy at work with both sides attempting to sway voters with the power of argument, passion and belief.  Although we have seen some dubious use of facts and figures, some scaremongering on both sides and some less than savoury comments at the fringes, this process has been free of violence, open to all and with everyone’s vote holding the same sway; that we should be both proud of and reassured by.

We are also seeing the markets at work, trying to make sense of what this all means and reflecting the aggregate view in market prices.  We are likely to see market gyrations over the coming weeks and months, but we should all remember to view it as short-term noise.   There are many ‘known unknowns’ as Donald Rumsfeld would say: we face an uncertain and likely tough negotiation to exit the EU, with unknown outcomes; an increased likelihood of another Scottish referendum and threat to the Union; and the knowledge that broad change is upon us.

As individual’s we need to try not to worry about things that we can’t control, such as what will happen to the UK economy over the next five years, or where the markets go in the next few days, weeks and months.  We should focus on things that we can control such as the structure of our investment portfolios.  As we have explained before, your portfolio is well positioned to weather this storm, both in its structure and the high quality funds that we recommended to execute your portfolio strategy with.  To reiterate:

Your portfolio is global diversified in terms of its equity exposure

It is worth remembering that the UK economy represents less than 5% of global GDP, and its equity market is around 6% of global market capitalisation.  The stock market is also not a direct proxy for the UK economy as many of its constituents have considerable overseas operations, such as HSBC and Shell.  In fact, around 70% of earnings from FTSE 100 companies come from overseas.

Your portfolio has well-diversified exposure to other developed equity markets and emerging markets economies and companies, which will help to mitigate any UK-specific market fall.  Equity markets as a whole might be volatile, but that is the nature of equity investing, and being diversified will help.

A fall in Sterling is actually beneficial to portfolio performance For Sterling Based Investors

Friday morning saw a big fall in Sterling against the US dollar and the Euro.  Ironically, this fall is beneficial to your portfolio if it is denominated in Sterling as the non-Sterling denominated overseas assets that you own are now worth more in Sterling terms.  That is an example of good diversification in action.

Owning short-dated, high quality global bonds delivers strong defensive qualities

The primary defensive assets in your portfolio are short-dated, high quality bonds, diversified on a global basis.   At times of market uncertainty, money tends to flood from more risky assets (equities and low quality bonds) into high quality bonds, driving yields down and prices up.  We have already seen early signs of this happening in the major bond markets this morning.

Have faith in your portfolios and resist the urge to look at its value too often. You don’t need this money today or tomorrow, so try not to worry about any short-term falls; that is the nature of investing.  This is a long-term strategy to meet your long-term goals.


After last night’s dramatic result our advice is as before – Keep Calm and Carry On.  Whilst markets have reacted savagely to the Leave vote, overreactions are not uncommon. The best advice at the moment is to remain calm with one’s investments and look for opportunities to rebalance portfolios as they arise.  As ever for any concerns you might have please call either Richard or Nils-Odd.

Brexit – Keep Calm and Carry on!

The impact of a leave vote on your portfolio
With the referendum to remain in, or leave, the European Union upon us, we thought it would be a useful time to provide some reassurance that the investment portfolio that we look after for you is well positioned to weather any investment storms ahead.
In this brief note, we raise a number of potential risks that exist and how these are mitigated, to a large extent, by the current structure of your portfolio. We do not seek to analyse the debate, provide our slant on it, or steer you in any direction.
How did we get to this?
There is no doubt that the decision that UK voters will make is a big one, with material consequences for the long-term nature of who/what we want to be as a nation. It is by no means an easy decision and is made no easier by the polarised positions of both camps that has resulted in unedifying personal attacks, the loose use of data, personal ambition and party division.
Today’s referendum is a long way from the heady days of 1973 when the UK – urged on by Ted Heath – became a fully paid-up member of the European Economic Community (EEC), by an emphatic margin of two to one. It may surprise some that back then those pushing for entry were the Tories and it was the Labour Party that was riven with in-fighting. Thatcher’s EU budget rebate in 1985 – which still rankles with some – and short-lived membership of the Exchange Rate Mechanism in 1992, were early milestones in the up-and-down relationship between the UK and the EU.
Despite the EU’s faults and challenges – not least the future of the Euro and coping with mass migration – it is easy to overlook the fact that, in all of its guises since the Treaty of Rome in 1957, the EU has been central to co-operation and peace between the nations of Europe, extending the principles of democracy and tolerance to its expanded ex-Soviet bloc members. That in itself is quite an achievement not to be dismissed – or risked – lightly.
How does all this relate to your portfolio?
Much has been written in the financial media about the need to position investor portfolios for a vote to leave (Brexit). Yet that presupposes that we, as your advisers (or any other investment professional for that matter) can, in some way, foresee what is going to occur and thus reposition your portfolio accordingly. It also presupposes that BREXIT is a bigger risk to your portfolio than, say Putin’s increasing militarism, the enduring tragedy of events in the Middle East, North Korea’s nuclear sabre rattling, Donald Trump becoming the next US president, or some other geo-political event or natural disaster that we cannot foresee.
When we established your portfolio, we did so knowing that any number of such events would be likely to occur with monotonous regularity over the time you will be invested. The aim therefore is not to try to reposition the portfolio for each such event – remember that the market’s view of potential outcomes is already reflected to some extent in market prices – but to build a robust, well-diversified portfolio to weather all investment seasons, with an appropriate level of risk for you, and to stay the course.
That said, we believe that there are short-term market risks to a vote to leave the EU that are worth understanding, which we highlight below:
Risk 1: Greater volatility in the UK (and other) equity markets
It is certainly possible that the UK equity market could suffer increased volatility – including a market fall – as the market tries to come to terms with what this means for the UK economy and the impact on the wider global economy.
Risk 2: A fall in Sterling against other currencies
Much has been made of a fall in Sterling against other global currencies, which has already been reflected to some degree in exchange rate movements since the start of 2016. For example, Sterling fell from 1.48 against the US dollar to 1.45 and from 1.36 to 1.27 against the Euro but has subsequently recovered some ground.
Risk 3: A rise in UK bond yields (and thus a fall in bond prices)
The Chancellor, amongst others, has stated that the cost of borrowing might rise as investors looking to hold bonds issued by the UK Government (and UK corporations), will demand higher yields on these bonds in compensation for the greater perceived risks of the uncertainty surrounding the decision to leave the EU.
Looked at in isolation, these may appear to be significant risks. Yet as part of a well-diversified and sensibly constructed portfolio, their impact can be greatly reduced.
Mitigant 1: Global diversification of equity exposure
It is worth remembering that the UK economy represents less than 5% of global GDP, and its equity market is around 6% of global market capitalisation. The stock market is also not a direct proxy for the UK economy as many of its constituents have considerable overseas operations, such as HSBC and Shell. In fact, around 70% of earnings from FTSE 100 companies come from overseas.
Your portfolio has well-diversified exposure to other developed equity markets (e.g. the US, Japan, Germany and Australia) and emerging markets economies and companies (e.g. Taiwan, China, India and South Korea), which will help to mitigate any UK-specific market fall. Equity markets as a whole might be volatile, but that is the nature of equity investing, and being diversified will help. Changing the mix between bonds and equities would be ill-advised. Provided you do not need the money today – which you do not – you should hold your nerve and stick with your strategy.
Mitigant 2: Owning non-Sterling assets and currencies in the growth assets
In the event that Sterling takes a beating, it is worth remembering that the non-UK equities that you own come with the currency exposure linked to those assets. For example, owning US equities comes with US dollar exposure, as we do not hedge the exposure out. If the Pound falls e.g. against the US dollar, these US assets are now worth more in Sterling terms, thus mitigating the fall in Sterling to some extent. In short, a fall in Sterling has a positive effect on non-UK assets that are unhedged.
The bond element of your portfolio has is hedged into your home currency to avoid mixing the higher volatility of currency movements with the lower volatility of short-dated bonds.
Mitigant 3: Owning short-dated, high quality and globally diversified bonds
The primary defensive assets in your portfolio are short-dated, high quality bonds, diversified on a global basis. Short-dated bonds are less volatile than longer-dated bonds and their prices will be less affected by any rise in yields. High quality bonds, tend to be where money flows to at times of equity market trauma, driving yields down and prices up, at least in the short term. Your bond holdings are also diversified across a number of different global bond markets, which mitigates the risk of a rise in UK yields (and thus falling prices), as the cost of borrowing in other markets will not be impacted in the same way.
Sticking to your strategy
At times like this, it is easy to become overly concerned about near-term events, such as the outcome of this referendum. Your life as an investor will inevitably be punctuated by an ongoing series of near-term events, making life continually uncomfortable, unless you view them in context. Below we reiterate a few thoughts that might be helpful. Remember:
• The value of your portfolio simply tells you how much money you would have if you liquidated your portfolio today, which you have no intention of doing. You only make actual losses if you sell assets. If you don’t sell them, they remain in your portfolio to deliver future returns.
• Your portfolio has a well-thought-out structure – as we explored above – that has been designed to provide you with the best chance of a favourable long-term investment experience. Stick with it.
• Some assets will be doing well at times and others less so. No-one knows which asset(s) it will be at any point in time. Markets work well enough to make jumping from one asset class to another a dangerous gambling strategy.
• Your adviser cannot control what markets do, nor can fund managers. Markets will do what they do.
Whether your inclination is to remain or leave, try not to worry too much about the consequences on your portfolio as you are well-positioned to weather any storms. ‘This too shall pass’, as the investment sage John Bogle has said many times before at other seemingly concerning times.

Can someone tell me what the markets did yesterday?

I’m a different kind of financial adviser in that I don’t watch CNBC, I hardly ever scour the market data section of the FT and I’m more worried about whether the temperature of the water for my coffee is correct (coffee geek alert – Aeropressers of the world unite) than whether markets went up or down yesterday. I learnt quite some time ago that both my own mental health and the interests of my clients were better served by ignoring all of the noise that those sorts of figures threw up and focussing on the big picture. Ok so it sounds as though I’m lazy but aren’t we all at heart? This isn’t laziness at work though it’s pragmatism. The fact is that trying to do anything for my clients based around movements over one day, one week even one month is pointless in terms of their long-term investing success. Yes we’ll rebalance clients’ portfolios when they move out of whack with the agreed risk levels, but we’ll always have a regular dialogue to discuss whether the agreed risk level is still appropriate or not. This will do more for them than trying to follow the markets on a daily basis. Indeed the evidence shows that those people who purely rebalance their portfolios on a regular basis do far better than those who try and react to the markets. I’ll use the evidence based approach thanks. Time to turn to the sports pages!

Twisting the facts on Active Management – redux

Today’s post is a blast from the past. In reality it’s an article I wrote for the FT back in 2010 in answer to a an article by an analyst and head of research at a division of ABN Amro. The thinking behind my article was that they had taken a piece of academic research and tried to twist the findings to suit their own ends. I’ll be the first to admit that my own thinking is biased and I probably look for justification for my thinking in articles and papers I come across – it’s a well known behavioural bias. I’d also like to think that I can be open to changing my thinking – I know I’ve had to be many times throughout my career. It’s therefore interesting to read something I wrote six years ago and reflect as to whether I have come across anything subsequently which may have caused me to question what I wrote. The answer is a resounding no! I stand by the following article as I feel it properly reflects the conclusions of the papers mentioned. I’d also like to point out that I was spot on with a prediction: ‘As we move forward perhaps other methods of gaining specific risk exposures will emerge allowing investors to move further away from active management’ but will claim no predictive capability but that I got lucky based upon a reasonable expectation as to what might happen.

One has to admire the pluck of Christophe Boucher and Bertrand Maillet in their article entitled ‘Case for active management is actually strong’ (FTfm May 3). Eloquently, they tried to twist the facts to suit their purpose of claiming that investors still receive real benefit from active managers. Most surprising was their citing of the 2008 Study False Discoveries in Mutual Fund Performance by Laurent Barras, Olivier Scaillet and Russ Wermers.
Whilst there is some encouragement for active fund managers in the study, as noted by Pauline Skypala, FTfm editor, back in October 2009 (Active managers: lucky, skilful or useless?) that same article also correctly stated that the study showed “only a vanishingly small proportion [of managers] (0.6 per cent) delivered positive alpha through skill”. Do Mr Boucher and Mr Maillet really think investors should rely on active managers having that most elusive of resources – luck?
Indeed they would be well advised to heed the words of one of the study’s authors, Mr Wermers, quoted in an article in the New York Times in July of 2008 stating: “The number of funds that have beaten the market over their entire histories is so small that the False Discovery Rate test can’t eliminate the possibility that the few that did were merely false positives,” or in other words lucky! As Mr Wermers said in an earlier article in the same paper: “By definition therefore, such a fund could not have been identified in advance.”
Rightly, Mr Boucher and Mr Maillet point out there are potential issues with investing in broad index funds based on the most well-known commercial indices. But what makes their case for active management even weaker is the fact that these indices, which are “somewhat arbitrary” and where “risk budgets and risk positions are not managed”, still outperform the vast majority of active managers year in year out.
Drawing on the experiences of Norges Bank and its management of Norway’s ‘Oilfund’, as it is commonly referred to, also strikes a further blow to the case for active management.
As has been mentioned in this paper previously, the fund’s use of active managers was analysed by Professors Ang, Goetzmann and Schaefer in a 220 page report. Given the fund’s resources and its time horizon one would suspect that if anyone has the opportunity to benefit from active management it would be this fund. The professors praised the extremely low cost burden on the fund (far below what any ‘normal’ investor could expect) but found that even with this advantage, the average active return from January 1998 to September 2009 was statistically indistinguishable from zero!
Interestingly, the professors also showed that the fund’s results are almost entirely explained by exposure to systematic risk factors rather than active management bets. The world of ‘passive’ investing has progressed from the ‘arbitrary’ state portrayed by Mr Boucher and Mr Maillet, allowing investors to target specific risk factors that they may wish to gain exposure to, such as size and value.
As we move forward perhaps other methods of gaining specific risk exposures will emerge allowing investors to move further away from active management. But we will surely never move to the state portrayed by passive management’s most ardent critics of everyone doing nothing but indexing. There will always be a substantial number of investors looking for the expensive thrill of active management allowing those of us who prefer a more prudent path to take the benefits.
To quote Mark Kritzman, lecturer in finance at the MIT Sloan School of Management, in a study from 2009: “It is very hard, if not impossible to justify active management for most individual, taxable investors, if their goal is to grow wealth.” Furthermore those who still insist on an actively managed fund are almost certainly “deluding themselves”.

Smart Beta Bingo!

Ok you know my starting point – the majority of the financial services industry is little more than a bunch of smooth talking, well dressed bullshit artists selling snake oil at anything up to 2&20 (the common term used to identify the ultimate performance bullshitters – hedge fund managers). If we were remaking a Western, the fund salesman would be the nattily dressed guy on a soapbox selling the latest cure for all the ailments known to man. So when the marketing wizzes, sitting in their Herman Miller chairs draw up their latest Powerpoint deck, they’re always looking for a fancy name or strap line to snare the unsuspecting, the gullible and the all too trusting. After all I’m buying a product from a mega bank what could possibly go wrong? Smart Beta is just one such term.

It has become the term used to describe what many for years knew as ‘factor’ investing. An approach which focuses on various return factors that academia has identified over the years which can help describe where the returns from a particular investment come from. Examples would include whether the size of a particularly company (its market capitalisation) whether it is a growth or a value stock, it’s profitability etc. Indeed when you include these factors into performance calculations it quickly becomes evident that a supposedly successful fund manager’s track record has less to do with his skill (alpha — which is mostly luck masquerading as skill anyway – just ask any fund manager to tell you how lucky he is and expect an embarrased laugh) in picking investments and more to do with the exposure to various factors within his fund. So the fund industry being nothing if not efficient at latching on to a money maker set up a whole raft of funds trying to take advantage of theses factors and has, I’ll admit on the whole, done a pretty decent job of it. After all security selection for these funds is straight forward, it can be done largely mathematically and thus is cost efficient so these funds are usually far cheaper than your average mutual fund (therein lies part of the secret – a cheap fund is likely to deliver better performance than an expensive one – time for Homer Simpson- DOH!). The problem has been that the fund industry as usual has been pushing funds with those factors that have done well – can we all say performance chasing? This issue was highlighted by Rob Arnot of Research Affiliates – an innovator and deep thinker in the world of investing – when he wrote a paper entitled ‘Can Smart Beta get you in trouble?’

Rob was not attacking in and of itself the idea of factor investing but highlighting the potential issues of seeing it as being a sure fire way to great performance. Ok at this point I’m going to declare our hand. We’ve been converts to the idea of factor investing for many years, starting back in 2004 so it’s nothing new. One of the things that we learnt when we were first introduced to it was not to expect to see ‘outperformance’ from any particular factor year in and year out. Academic studies showed that based on what we have seen historically that over time one should expect to see overall outperformance from exposure to certain factors such as small cap and value stocks but that these factors can have long periods of underperformance, as with the value factor in recent years.

So are these factors really that ‘smart’? Not in my opinion. The academics who identified them are – in fact they’re some of the smartest finance minds around but these factors just are! They may give you periods of underperformance, they may give you periods of outperformance and on balance the evidence would suggest that over time you will get performance over and above what you would have had if you hadn’t have weighted your portfolio towards them. When are you going to get the outperformance? I haven’t a bloody clue and nor does anyone else. If they suggest they have they are a charlatan and a liar – take your money and run. Like anything they are something to take into account when taking a science based approach to constructing a portfolio but don’t bet the proverbial ranch on them because you might end up feeling like a bit of an idiot and not many of them are very ‘smart’ are they?

Why Robo-Advisers might be the Traditional Adviser’s best friend

I recently attended a presentation by a Robo-Adviser on ‘The Future of Advice’. If it had taken place in the UK I might have sued under the trade descriptions act. There was absolutely nothing new about the ‘advice’ side of the business but plenty of interesting stuff on automation. Let’s not beat around the bush, I think automated forms of advice for many people will be an absolute godsend as the regulators and governments in their ‘wisdom’ regulate away the possibility of human advice from many people who desperately need it. Globally we’re faced with an almighty challenge to overcome illiteracy – financial illiteracy and as long as we have that problem most people won’t be able to help themselves when it comes to their finances. Indeed left to their own devices most people do fuck it up when it comes to such an emotive subject as money. I really wonder what’s going to happen to some of these Robo-advisers when the shit hits the fan and you know it always does. I seriously wonder how happy people will be to follow their account as it is sensibly rebalanced and buying into a falling market without someone there to explain to them why this is sensible. When people invest they need to be educated, we need to explain to them how they are going to feel when bad things happen to their portfolio and what we’re going to do about it. We don’t need to do it with lots of complicated tables and figures but with pictures and comparisons to other situations in life that they can relate to and we need to be able to listen to how they react and how their emotions are influencing their thinking. That is something that humans do best. Until now I haven’t come across a machine that can compete in that arena.

So why might Robo-Advisers be a traditional adviser’s best friend? Simply because of the rethinking of the technology that we use in finance. I see the technology they are using of being of huge use to traditional advisers by simplifying a multitude of routine tasks and enabling advisers to collect, collate, apply and present data in a manner that is more intuitive, less intrusive and more applicable. As I said in my previous post, in our industry we have become masters of deception and obfuscation. If technology can help remove any of this layer of fog that the industry has set up and makes it easier for people to get sensible advice that they can apply consistently it will be welcome. We have to lower the hurdles that people feel confronted by when seeking financial advice and then we have to lower the hurdles in their way on the path to getting to where they want to with their finances and their lives.

Why the Finance Industry needs to extract its head from its own backside and focus on big stuff!

Firstly please excuse some of the language in this blog. I know my mother reads it so I’m sure I’ll be getting an angry call at some stage but my feeling are strong on this issue.

I recently returned from what I consider to be one of the best finance industry conferences around, the CFA Institute Annual Conference. It’s always an impressive affair, this year attending were over 2’000 of some of the finance industry’s most highly educated professionals, prominent finance journalists, industry thought leaders and yours truly! The list of speakers is always impressive and usually very wide ranging. This year there were well known non finance names such as Daniel Goleman and Sir Bob Geldof as well as a host of leading thinkers speaking on various financial and strategy related topics. A lot of the content was excellent. Thought provoking and well delivered. Following a few exchanges over the last couple of days on Twitter it strikes me however that these sorts of conferences probably spend too much time focussing on things our clients care little about. The finance industry is obsessed with numbers and formulae, constantly seeking to find better explanations for market behaviour that we may never properly understand completely, looking to lower risk and constantly seeking to eek out a few extra percentage points of return. The vast majority of private clients couldn’t give a stuff about this finance industry bullshit. It’s largely navel gazing and designed to protect the illusion that we’re so much smarter than our clients when it comes to finance that they need to pay away an unsustainable amount of their investments in return for our services.

Trust me I’ve been there. I was basically told by my former employer that I had to go out and sell a fund they were launching but couldn’t deliver full transparency on the underlying managers they were using (it was a hedge fund of funds) due to various confidentiality agreements but that the managers were so large and exclusive that they need have no worries. What a pile of crap!

Most of our clients focus mainly on getting from point A to point B with their finances. They may want to ensure they have enough in retirement, they may want to provide for their children or grandchildren’s education, give to charity etc etc – big important stuff. Most of them couldn’t give a stuff about whether what gets them there does so with 16% standard deviation or 14% standard deviation. Most of them couldn’t give a stuff whether the funds we use have an active share better than their peers or whether the funds add value though a three factor of five factor model. All of that is to be honest a load of bollocks. The fact is we’re much further away from being as accurate in our assessments of what are our clients are really after than we are in our assessment of the sources of returns from our portfolios.

How often when you go to buy a car do you make a decision based upon a difference in fuel consumption of 3%, a difference in engine power of 15 brake horsepower? You look for something that will meet multiple goals. The last time we went through the exercise of buying a car eight years ago, we needed something big enough for three (hopefully four) people, luggage capacity for a Scandinavian style pushchair, good fuel consumption and environmentally friendly. We ended up with a Toyota Prius and have to say it has met all of our needs admirably, coupled with excellent aftercare from our supplier. We were in a decent position to be able to assess our own needs in that situation but when it comes to our finances, most of us struggle without guidance to properly assess what we need. If we spent more time focussing on ways and means of doing this and doing it well, differences in standard deviation, adherence to the benchmark etc would pale in comparison to our ability to get our clients closer to where they want to be in a manner they feel happy with.

We need to get better at the people side of our business. How we understand and relate to our clients – empathy. This should outweigh any other focus within financial services. In his speech to the CFA Conference Daniel Goleman Goleman said there are three kinds of empathy:

Cognitive empathy: You understand how a person thinks about things.
Emotional empathy: You tune into the other person. You can build rapport or chemistry.
Empathic concern: That’s what Goleman calls “the Good Samaritan empathy,” or caring about people.
Empathy is the foundation of relationships, Goleman said. The better we get at these skills the better will be the results we produce for our clients.

My recommendation therefore: forget that latest book about some new fangled portfolio construction model (it will probably do sweet FA for your results anyway) and read something that can help you relate to other people more effectively or broaden your way of thinking. Try looking anew at the sort of conversations you have with your clients. Are there ways in which you could get to understand them better? Together with my business partner I for one will be reassessing how we interact with our clients with a view to working out where they want to get to and how they’d like to get there and I’ll be talking as little as possible to them about how wonderful our investment strategy is. After all most of them would rather watch paint dry. All of this empathy and understanding is the big stuff. The numbers and formulae etc the little stuff. Only when we get better at the Big Stuff and actually use it properly will the public start to trust the financial services industry again.

I’d like to thank my friend Lauren Foster for her excellent write up of Daniel Goleman’s presentation which I blatantly cribbed from. Thanks to Ben Carlson, Philippe Maupas, John Bowman and Robin Powell for the recent exchange of Tweets on the ‘Big Stuff’ and apologies to any investment nerds I’ve offended (fear not, I like the techy side of our business and am happy to discuss it but this stuff matters more). And to all those offended by any of my language – do one! You’ve heard far worse on any drive to work listening to the radio when a rap tune comes on.

Why liking your financial adviser is not a good enough reason for using their services

The recent rise of so called robo-advisers sparked some thoughts about the importance or not of human interaction in the financial advice process. I’m on the side of those who believe that the vast majority of people benefit from having a human adviser to assist them particularly in the initial planning phase and also when the markets start ‘misbehaving’. This post isn’t about that debate. Plenty of other people have covered it extremely well in numerous other blogs and articles. This blog is more about why liking your adviser is a whole lot less important than the process they guide you through.

Over the course of the last few years myself and my business partner have come across a number of potential clients with portfolios managed by other advisers. Often the clients have talked about the very good relationship they have with the adviser and how they feel well looked after. When they show us how their portfolios have been constructed however, we’ve often been shocked by how poorly we interpret those portfolios to fit with what the clients want to get out of their finances and proper measures and discussions of their overall need and capacity to take and willingness to bear risk. Indeed one well know brokerage house here in Norway had constructed a portfolio for a lady in her late 50’s with no other income, comprised purely of Norwegian equities. At the time we spoke to her the portfolio had had a good run but we pointed out how poorly it actually met her overall needs and how it was exposing her to a considerable amount of unnecessary risk. Whilst she appreciated the time and trouble we spent exploring the various issues with her she decided, after a period of reflection, to stay with her current adviser because he was so nice to her. I hope that things have worked out for her ok but fear that she may have been through a rough time recently given the way the Norwegian market has behaved. Our job as an adviser is not to be a friend who bends over backwards to agree with you and please you. Yes we will always deliver the best service that we can but we’re going to do it combined with a disciplined process which will sometimes involve us disagreeing with you, getting you to reexamine your thinking on certain issues and from time to time flat out telling you that you’d be an idiot to go ahead with a certain course of action.

You need an adviser who can be honest with you, at times brutally so if you want the chance of having a financial plan that works successfully for you. I sometimes tell people that part of my job is to stop them being an idiot with their money and that they’re going to have to pay me for the privilege. That might put some people off – that’s fine with me. If it’s the case they’re probably the sort of people who might think twice about some honest advice when it’s needed most. A good adviser will be able to demonstrate how their process serves you in terms of analysing your needs translating that into an investment portfolio and other related advice and how they follow up and reassess your plan on a regular basis. If they can’t document this and show you examples of how they’ve employed this process successfully, preferably with client references, then take your money and run elsewhere.

Rationally Irresponsible – personal thoughts

The recent revelations that Barclays have been massively fined for fixing what is now being called Lie-bor coincide with the news that J. P. Morgan’s trading loss could reach as much as $9bn – yes this from the bank that seemed to think it was smarter than the rest in avoiding the meltdown of 2008. Elsewhere Matt Taibbi of Rolling Stone wrote recently about three GECapital employees being convicted of rigging the prices at which Bonds of Municipalities trade in the US effectively costing these local authorities of billions of dollars. They managed to do this with the help of a range of well known big banks.

One would have thought that the financial crisis of 2008 would have washed out most of the evils of the financial system but it is clear that the potential rewards are still so great that unethical, irresponsible and illegal behaviour will persist for the foreseeable future.

Sadly this sort of behaviour exists all the way down the financial food chain rearing its greedy mouth in the form of complex products with exotic and extortionate charging structures being ‘flogged’ often to those not in a position to be able to make an informed judgement as to what they are buying.

If I were a pessimist it would perhaps dismay me to be part of the financial services industry but I take heart from the efforts of others who share my view that you should always act with your clients best interests at heart. I’m convinced that the overwhelming majority of people in the industry feel the same way and valuable initiatives such as those being undertaken by the Institute for a Fiduciary Standard in the US are huge steps in the right direction. As ever the actions of an irresponsible minority seduced by financial reward are spoiling everything for their follow industry participants but most of all the clients and customers who place their trust and hard earned money in our hands.

Nothing Ventured Nothing Gained?

Over the last few years, private equity investing and in particular, venture capital have generated more than their fair share of headlines. It has been argued that one of the main reasons for the excellent returns generated over the longer term by some investors such as the Yale Endowment has been their access to high performing venture capital funds which have generated returns far in excess of what could be achieved in the public equity markets.

As institutions search for ways in which to extract fee income from clients, it would seem that access to these types of funds has been reaching further and further down the investing food chain such that they are no longer seen as being exclusively the preserve of those living in the investing ‘stratosphere’. So should you seriously consider investing in what has been until recently a relatively difficult area for most investors to access?

One of the big questions has been whether it is actually possible to access the sorts of outsized returns often mentioned from this type of investment. A recent report by the Ewing Marion Kauffman Foundation in the US shows that accessing these returns may b much harder than thought.

The Kauffman Foundation is one of the largest foundations in the USA and has a portfolio of $1.83 billion supervised by a sophisticated investment committee and and extremely well respected Chief Investment Officer in Harold S. Bradley. As should any good investor, the Foundation decided to do a periodic evaluation of its strategy and focused on the returns to its investments in venture capital funds. Their findings published in a report made pretty dismal reading for those hoping that top notch venture capital returns could be accessed with the right sorts of resources.

Given the size of the Foundation’s portfolio and resources, one would expect them to be able to connect with the very best venture capital funds and be able to analyse who best to place their money with. Sadly as previous studies in other areas have shown (most notably with the Norwegian Oil Fund’s inability to successfully pick outside managers) trying to pick winners proves incredibly elusive. Amongst the studies findings were the following:

Since 1997 returns in VC funds have returned less cash to investors than has been invested in these funds.

Only twenty of the 100 funds in which it invested generated returns that beat the public market equivalent by more than 3% annually.

The majority of investments underperformed the public markets, net of fees and expenses.

Only four of thirty funds with committed capital of more than $400 million delivered returns better than those available from a small cap common stock index.

78% of the 88 funds in their sample “did not achieve returns sufficient to reward us for patient, expensive, long term investing.”

As Dan Solin of Index Funds Advisors stated in his excellent blog on the study :
It’s not all bad news. Someone made a lot of money from these funds. The fund managers charge a whopping 2% management fee and a 20% profit-sharing fee. Regardless of the fund’s performance, they did just fine. Ironically, they profited handsomely without taking meaningful risk.

So the evidence from this study would seem to suggest that as with investing with most active mutual fund managers, a venture capital fund is likely to produce returns which do not make up for the significant risk of a major loss of capital you run with is asset class, and the majority of funds produce returns worse than that offered by low-cost index investing.

These findings are in line with other research we have come across both as regards venture capital and its big brother in private equity buyout funds. The risks in these asset classes are often high and the returns elusive. While some investors may indeed get lucky and pick the right fund at the right time the majority of investors will end up doing little more than transferring an unnecessarily large amount of their wealth to a fund manager whilst experiencing returns worse than could be achieved with straight forward low cost index investing.