In the recent article by author and lecturer, Peter Thornhill, he made the case for a long-term asset allocation of all Australian shares. His main argument was the long-term superior income backed by capital growth, but it requires investor tolerance of the inevitable short-term fluctuations in the market value of their portfolio. Peter argued investors should focus on income, and dividends are less volatile than market prices.
The article was a response to a piece on life-cycle investing by an equally well-credentialed expert of long-standing, Don Ezra. We have also published Don's further contribution this week.
Some comments on Peter's article highlight another serious issue. Financial advice as a profession has taken a beating over recent years, most notably in CBA-aligned licencees, with millions of dollars of compensation paid to clients. There is no doubt that some poor advice was given including cases of fraudulent activity, leading to ASIC investigations, the Future of Financial Advice (FoFA) legislation and the current Royal Commission. Clients argued they did not understand the risks in their portfolios when entering the GFC, and cases such as the elderly lady invested in a geared listed property fund are high profile examples of advice failure.
What is rarely acknowledged, however, is that many people took advantage of the media and regulatory focus on financial advice and made ambit claims, even when they knew the risks they were taking. The Australian share market ran strongly in the five years to 2007, and investors wanted a piece of the action and enjoyed the hefty gains. When it went bad, many saw an opportunity to claim innocence. I was working at Colonial First State at the time, and amid the obvious problems, a lot of appropriate advice was also targetted by clients simply because exposure to shares had resulted in losses. It was a chance to recover some money, what some called a 'put option' back to the bank. As the media hype became hysterical, CBA virtually waved the white flag and made payments in cases where internally, it was strongly felt clients knew exactly what was in their portfolios, and had knowingly signed their Statements of Advice.
Advisers started ducking for cover and banks such as ANZ have stepped back from the advice business. In fact, CBA and Colonial First State have lost confidence in defending their rights and the merits of financial advice given, and would rather write $100 million in cheques than face further slamming of their reputations.
Many advisers do not give the advice they believe in, faced by a potential legal liability and the worry that clients will panic amid the media whipping up fear.
Comment by Andrew Rowan
"As an adviser for 25 years, my career commenced in 1993, and shortly after that, I came face to face with the Bond Crash of 1994, when even 'safe' investments fell in value (collapsed), and obviously every 'crash' since that time.
When I was younger, I compiled possibly too many spreadsheets to prove theories such as yours (ie Peter Thornhill's) for myself using actual client situations; nowadays I am happy just to know the truth.
My observation over time is that volatility has never really mattered in client portfolios provided that they have had sufficient cash to meet their income and 'emergency' needs.
In theory, I would like all clients to say hold near 100% in equities in their portfolio. However in the real world as advisers, we have to contend with the media setting expectations and trying to scare the daylights out of the public whenever the sharemarket undergoes repricing from time to time (what they call Australians losing 'billions').
Coupled with this, is the concept of 'Risk Aversion' where some people simply do not have the appetite for any volatility, such is their fear that they will lose their hard earned.
In such cases, and as advisers we are under an obligation to 'know' thy client and invest their funds accordingly. I know that when I invest a client’s money in a 'conservative portfolio', I am setting up the client to earn less over time.
If on the other hand, I were to do the right thing by the client and invest in a way that we know the client will be better off (i.e. shares), then when next the market falls, my conservative client will in all likelihood complain. This could then cause them to sell their investments of their own volition and crystallise the 'loss'. This scenario would likely end up with me meeting the lawyers.
In my experience volatility for our clients is a concept until it becomes real, and the portfolio report shows a 'loss'. That is when the real test is applied, and then when they listen to the media, they panic.
My question then is how in the face of knowing what is right, how then do we deal with the reality of fear, risk aversion, misinformation and prejudice in clients."
Comment by Phil Brady
"Excellent summary of the problem Andrew and sums up the dilemma of managing multiple clients, not just your own portfolio, or Peter’s in this case, on which you can manage your own emotions or not. Much more difficult to manage other’s emotions. Part of the answer is education, but in my experience as well, the education may not actually sink in, or it is abandoned when fear becomes real, hence we revert to the ‘safe’ approach. The no win no fee lawyers would have a field day with portfolios 80% in Australian equities, no matter the theory. That’s why some choose to be educators and theorists I guess, and not personal advisers!"
Comment by Rob
"I once considered very seriously becoming a financial adviser (I was already involved in the finance industry in another capacity) however I was unable to reconcile my own firm views on high ASX asset allocation and the importance of income above all else, to the 'standard' approach of the 'balanced' portfolio and the much lower outcomes that must occur as a result.
So I just stayed where I was and in the end was able to personally retire some 10 years ahead of most, if not all, of my colleagues and peers. This is not to 'brag', I actually state this with a sense of disappointment for the missed opportunities of the majority caught up in the mire of the bog standard asset allocation world."
Concluding note
The increasing amount of compliance and legal obligations faced by advisers is one reason many are leaving the large advice groups and becoming Independent Financial Advisers or setting up themselves. Every adviser faces significant paperwork obligations each time they hand out personal financial advice, including the 70 page Statement of Advice, the Approved Product Lists, the Professional Indemnity Insurance, the administrative platform and the model portfolios. It limits the scope for individual advisers to follow their instincts and accumulated knowledge as they fear the backlash from advice that goes wrong. Michael Kitces argued that the future of financial advice is specialisation, not these generic responses and institutionally-based rules. In the meantime, financial advisers will give the advice they've been told to give.
Leaving the last words for Peter Thornhill:
"I have always felt for advisers. Know your client? What a joke. You know many of them only until things don't go their way and then it is your fault. The GFC was a great opportunity for many 'clients' who signed off on their plans to activate a 'put' option."
Graham Hand is Managing Editor of Cuffelinks.