Private clients have a wide array of options to choose from when it comes to picking the methods of investing in financial markets.
They can invest in financial instruments (stocks, bonds, derivatives etc) directly; in funds managed by professional managers; or some combination of these two.
Increasingly, we see clients who are in favour of delegating their investment decisions in part or fully to the professionals.
Why would high net worth individuals – many of them successful businessmen in their own rights – outsource such decisions to someone else?
Sync your investment decisions with your objectives
The first and most obvious advantage is that doing so helps to align clients’ investments with their objectives.
The sad truth is that many investors do not fully consider the reason why they are investing in financial markets in the first place.
Different investment strategies will deliver very different outcomes in terms of risk and return.
For example, a decision to invest to deliver a set income stream to offset a series of liabilities results in a different strategy compared to one where the objective is capital growth.
The length of time that the investor will be in the market also plays a role in deciding on a strategy, as will the ability to withstand short-term shocks to the portfolio.
There are many other additional factors that can determine which way to invest and all of these need to be carefully considered before embarking on the investment journey.
This process can be complex for individual investors, but it can be vastly simplified by engaging the advice of a discretionary manager who can put in place a framework that will meet the requirements of the investor.
We can sometimes be our own worst enemy
Research suggests that investors hurt their own performance by making a variety of mistakes when they invest.
Many are not even aware they are making these mistakes, which largely stem from the very nature of being human.
It is tough for investors to admit these, and even harder to operate an investment strategy that accounts for and corrects these errors.
In an earlier article I had written, I highlighted the human biases that often sink investors.
The modern world is awash with news reporting on markets and social media has proliferated the amount of information, opinion, data and analysis.
But much of what passes for analysis is not that; it is merely noise.
Because some individual investors are less self-aware of the effects of the behavioural biases inherent in our nature, a growing abundance of information can sometimes exacerbate poor decisions.
Market research film Dalbar Inc found that in 2016, the average equity mutual fund investor underperformed the S&P 500 by a margin of 4.7%. Over 20 years, the gap was 2.9% annualised.
Sticking with a tried-and-tested structured approach to investment is likely to prove more successful than trying to go at it on your own.
Is there ever a good time to buy and sell?
The simple idea that it is possible for investors to make profits and avoid losses by timing the market is flawed.
The notion that investors can regularly buy a stock at a low and sell it at a high just does not hold true.
In fact, it is investors who stay invested who end up reaping the maximum benefits from the markets.
Using a hypothetical investment of $10,000 in the MSCI World Index between 1999 to September 2018, the chart below illustrates this point.
An investor who remained invested throughout the 20-year period would have earned a 5.22% annualised return.
The annualised return shrank to 2.19% if the top 10 best-performing days over that time period were missed and would dip even further to just 0.24% if investors missed out on the 20 days with the largest gains.
What would tip the investment into negative territory? Just by missing out on 30 of the best-performing days.
To put things in context, 30 days represent only 0.6% of the total of 5,150 trading days over this period.
People who rely exclusively on market timing need to be confident that they will not miss the best days in the market as, over time, the compounding effect from missing out on the markets’ strongest days does serious damage to your portfolio.
Panic buying and selling
The longer you stay in the market, the lower the probability of losing money from a well-diversified portfolio.
Knee-jerk reactions to short-term volatility, without due consideration to fundamental factors, seldom produce the desired results of better returns.
In fact, these more often than not tend to cause long-term damage to portfolios by being out of the market at the wrong time.
Panic selling in the face of market volatility is a losing strategy in the long run.
Avoid the latest fads
On social media, hype has a way of getting over-hyped.
This means that the latest fad you have read about or seen may be more fluff than substance.
The problem with using fads to guide investment decisions is that they tend to be short-lived. And it’s hard to estimate when the fad will make way for the next big thing.
A better plan is to ignore the fads. Instead, focus on remaining invested in the correct long-term strategy after consulting a professional discretionary manager who operates a disciplined investment process.
A little bit of diversification goes a long way
When trying to put together a diversified portfolio, investors often become too focused on specific securities and are overconfident in their ability to spot ‘winners’ or simply be unaware of the dangers of concentration risks.
Broad diversification is not just an issue from the point of view of long-term allocation.
Avoiding concentration is another key benefit that comes with diversification.
The market being the unpredictable place that it is, there can be no guarantee for any investor, private or professional, of avoiding all bad outcomes.
Take a bond default as an example. Such defaults happen occasionally.
In a concentrated portfolio of only a few bonds, a default can wreak havoc on the overall portfolio.
However, in a diversified portfolio, the same default would cause far less damage and could even be barely noticed in a well-managed portfolio.
For example, a 30% decline in one bond will result in a 3% loss in a portfolio of 10 bonds, but only 0.3% loss in a portfolio of 100 bonds.
The question then is how many bonds do you need to be adequately diversified? My personal experience is that one needs at least 50 bonds.
Due to many bonds having a minimum investment of $200,000, this means that a client would need to invest at least $10 million for their bond portfolio to be adequately diversified.
The same applies for equity portfolios. Sharp losses in single securities in the equity market are not uncommon and a well-diversified portfolio can help you ride it out.
Trust the professionals
What I’ve spelled out are all powerful reasons to prefer discretionary fund management over going at it alone.
In the long term, clients are likely to be much better off in a solution which provides a structured approach that avoids the common pitfalls all investors are prone to and ensures a broadly diversified portfolio.
Moreover, delegating management of their financial assets does not just improve performance.
Many clients are successful businessmen and their time is better spent running their company or, alternatively, enjoying the fruits of their success.Disclaimer applicable to recommendation
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