The View

Your financial advisers aren’t telling you all you need to know

Eight years of zero interest rate policies have distorted the price of risk, and created bubbles that severely inflate the stock and property markets.

PUBLISHED : Thursday, 08 June, 2017, 10:46am
UPDATED : Thursday, 08 June, 2017, 10:46am

Your financial advisors are not telling you everything you need to know about why your portfolio will fail your retirement goals because you were too afraid to ask.

Asset managers, banks and fund distributors - the entire financial industry - will surely protect themselves like the priesthood defending its faith. Asking the tough questions about today’s markets to fund managers equals apostasy.

In my 1st June column, I revealed serious historical data analysis problems involving the measurement of the effects of quantitative easing - raising rates after eight years of zero interest rate policies. Now that may sound arcane to most readers, but here is how it relates to the average investor.

The zero interest rate policy has distorted the price of risk, creating bubbles, severely inflating stock and real estate markets.

But the zero rate is also arguably an immoral monetary policy because it deprives and threatens the most vulnerable people such as retirees and students who are highly dependent on interest income.

Worst of all, it has driven average investors into making investment choices that they are uncomfortable with, and ignorant about.

The relentless higher march in stock prices over the last eight years has inflicted an oblivious, numbing illness on investors and their advisors. The grinding climb has been supported by relatively weak fundamentals that cannot justify such elevated prices.

The entire environment has coerced asset managers into creating increasingly convoluted funds, some of which are really hedge funds or private equity funds masquerading as investment vehicles suitable for the general public. In fact, investors are unwittingly taking much more risk than they are aware of, or being told.

One especially egregious example that I have witnessed around town is investment advisors pushing clients to buy complicated, hard-to-explain, and even harder to understand, funds with obscure names like “Sigma Alpha.”

They employ algorithmic trading and other complex quantitative strategies that can’t be properly explained without a math or physics background.

Another potential investment quagmire is funds that invest in the construction of dormitory housing for students. Advisors tout them as a “sure thing, low risk, high return” project backed by an expanding population of students.

What investors in such funds don’t realise is that these are essentially “private equity” operations where the underlying investments are non-listed, non-cash flow generating assets, which are far more illiquid than listed stocks or bonds.

Investors only learn about the meaning of the lack of liquidity when they try to sell their units and their advisors have to explain to them they can’t redeem all of their units at once. The manager often doesn’t have enough cash on hand to satisfy a substantial redemption. In other words, investors can’t take their money out as and when they need, say to head off a crash.

These kind of private equity funds are best suited for long-term investors who have about five years to wait for investment returns. Unfortunately, few advisors tell their clients that it won’t be easy to redeem their units in the short term.

Then, there is the Millennials’ dilemma. Having witnessed their parents’ woes after enduring market crashes in 1987 and 2008, studies have shown Millennials to be sceptical about home or car ownership, or traditional investment. Financial technology innovations such as roboadvisors supposedly offer automated or artificial intelligent investment advice to save fees.

But by making recommendations based on lifestyle questionnaires and then delegating investment strategy to a black box (as far as the client is concerned), these sites create a false sense of security.

In reality, the client doesn’t know that he may actually be taking excessive risk as the roboadvisor invests in complicated derivatives and structured products without the clients’ knowledge.

Arthur Schopenhauer, the German philosopher, would describe Millennials’ investment strategy as being like highly spirited children eagerly awaiting the opening of a theatre play. “It is a blessing they do not know what is really going to happen.”

The other style - active asset management, is under tremendous pressure. About 80 per cent of active funds report underperformance to their relevant index every year. Managers struggle to justify fees. Sadly, the average investor would have done better buying large cap, growth tech companies such as Google, Apple, Amazon and Facebook over the last eight years than investing in funds.

The punchline is these stocks represent the major holdings of many hedge funds so investors are wasting money paying funds for superior advice.

And these company’s reports and news are actually easier to understand than the reports and prospectuses of funds.

It has never been harder to create a sensible investment plan that suits your risk profile and to stick to it. One of the cardinal investment rules is to never buy into bubbles. But, today the entire stock and real estate markets are bubbles.

Then, savvy investors point out it is only a bubble if you aren’t already invested and profiting.

Peter Guy is a financial writer and former international banker.