September 2011

EQUITIES: Are they being served?

ButlerApproaches to equity investment have been shaped by the 2008 crisis. Mark McFee finds evidence of this in the August sell-off and looks at some of the current thinking surrounding investment for institutions, retail and wealthy clients.
Do you remember the last stock market slump and how a few sage voices said investors should see the post-Lehman turmoil as a buying opportunity? Well, it could be that institutional investors who didn’t have the nerve then to increase their equity allocations have learnt from those who did have the nerve and made fortunes from the fall and rise of banking and other stocks. In the recent August sell-off of equities across the world, Virginie Maisonneuve, head of global and international equities at Schroders, saw certain institutional investors apply what she says was a combination of experience and learning to buy, not sell, more equities as markets went lower.  “I’ve been through quite a few of these crises but I’ve never seen the same attitude in terms of institutional clients adding to the market in a crisis environment,” she says. Yet the situation with individual retail clients, who may be more likely to retreat from falling markets, has probably not changed, as figures for fund outflows would suggest.  Difficulties with asset allocation are particularly endemic where these kinds of investors are concerned. Mark Dampier, head of research at Hargreaves Lansdown, a UK financial adviser, says: “The vast majority of investors are completely illiterate when it comes to investing, and why would they not be? It’s not taught at school.” The situation is exacerbated, says Dampier, because individuals’ pensions are often managed for them, including defined contribution schemes where many members opt for a default fund. Even where the individual may be more informed or have access to a greater level of advice, other factors can hinder a sensible approach to asset allocation. Ultra-high-net-worth (UHNW) clients can be affected by the same psychological phenomena as retail investors, says Frank Frecentese, global head of hedge fund investments at Citi Private Bank.  “Certain UHNW clients are able to put emotions aside, and some have objective counsellors… but I’m not sure that’s universal throughout the UHNW space,” he says.“Probably 75% of our clients come in thinking about equity investing or hedge fund investing in terms of risk and return and there are a lot of other dimensions that we have to bring to their attention, such as liquidity and lock-ups.” Serving up solutions
Reflecting a current that is running through the investment industry at present about ‘solutions’ rather than ‘products’ and about investing for specific ‘outcomes’, Dampier at Hargreaves Lansdown says: “Unless you know what someone is trying to achieve, how can you tell what [investment] they might like to look at first?” This applies as much to retail individual investors as it does to the very rich and to institutions. With derisking becoming a major theme for pension funds, Mercer Investment Consulting is advising on low-volatility portfolios for clients that have to juggle the meeting of their liabilities with potentially lower risk investments.  Mark Gee, an investment consultant at the firm, says: “[With low-volatility portfolios] you have the bias of two areas: high potential growth in the future, balanced with an inherently lower volatility strategy. “In the long term you’re getting the same level of return but with a lower level of volatility.” This is achieved partly by investing in shares of companies that are expected to be, or have historically been, less volatile. Equities do not fit everyone’s risk profile, so some firms have attempted to obtain equity-like returns from less risky securities.  In 2009 F&C launched a range of four equity-linked bond funds aimed at small and medium-size pension schemes and the firm says these have been successful. The strategy is to have 75% invested in long-dated gilts and 25% in cash. The targeted 100% exposure to equity returns is provided by a position in equity futures.  Julian Lyne, head of UK institutional business and global consultants at F&C Management, says: “For some it’s been very successful because it allows them to increase their duration and their matching assets and also ensures that they don’t lose the benefits that they could gain from having 100% equity exposure.” Solution-led investing is also on the rise in private banking. At Citi, Frecentese highlights an emerging strategy that is trickling down from sophisticated institutional investors and involves allocating between alpha and beta investments instead of traditional and alternative strategies.For example, an investor that wished to put, say, 4% in hedge funds and then 7% in mutual funds could end up with a much higher beta exposure than these figures would suggest – perhaps 9%. “In the world of hedge fund investments the focus is on generating alpha which is uncorrelated to the markets. Therefore certain clients will not be happy if the S&P is up significantly and their portfolio is not,” Frecentese says. “People had assumed that hedge funds were pure alpha. That’s not the case anymore, so that is affecting exposures.” Yet while high-net-worth investors can benefit from increasing customisation of portfolios in line with their aspirations and liabilities, the retail outlook is less rosy. Dampier says that he does not see the adviser-led UK industry rapidly moving away from simply selling products. The advent of the UK’s retail distribution review (RDR) and the subsequent adviser charging could leave many investors priced out of the market for financial advice. The latest annual survey by the UK’s Investment Management Association (IMA) observed the shift in thinking on client servicing and mooted the development of more unconstrained or benchmark-unaware strategies, and further use of absolute or target return funds. With equities having seen enough volatility to fray the nerves of the most seasoned of investors over the past few years, this asset class could stand to gain a lot from products that take a more considered approach to the people that fund them. ©2011 funds europe

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