Negative interest rates highlight mismatch between advisor and client investment horizons
Negative interest rates are not just creating unprecedented uncertainty in investment portfolios and signalling another financial crisis. But eight years of near zero rates are also challenging how clients invest and the relationship between them and wealth managers.
Today there is US$11.7 trillion invested in negative yield sovereign debt. This includes US$7.9 trillion in Japanese government bonds and over US$1 trillion in both French and German sovereign debt. James Grant of Grant’s Interest Rate Observer lamented, “If these are the first sub-zero interest rates in 5,000 years, is this not the worst economy since 3000 BC?”
The signals given off by sub-zero rates are confusing. Negative rates are supporting risky assets, which explains why the stock markets have reached historical highs. The bull market in equities is not a sign of general prosperity for the entire population. For example, the yield curve for Swiss bonds is sub-zero for the next 30 years, suggesting that investors expect negative rates to persist for some time.
Investors have to be careful not to fall into the intellectual and trading trap of believing that future investing and investment management conditions will be similar to the past. Economic theory says zero rates are the floor in monetary policy as rates must rise. Negative yield bonds certainly represent a poorer investment than cash.
If negative yields continue to spread like a plague then some savers and depositors will not countenance the certainty of compounding losses. They will likely hoard cash, which returns zero per cent. However, a move to cashless economies –a virtual digital confiscation of liquid assets, will prevent hoarding and radically reshape society.
A mismatch between advisors’ performance and their clients’ expectations ultimately lead to a break up. An investment horizon of less than five years probably means you aren’t suited for traditional wealth managers or private banks.
Investors have always been a nervous bunch, writhing in psychological contradictions and overwrought hopes and dreams. No one wants to admit that everyone wants to go to heaven, but no one is willing to die.
Investor flight and turnover has been high since 2008. If a financial advisor convinced his clients to stick to an equity heavy portfolio during the 2008 financial crisis then their portfolios would have performed well to date.
Given the unusual financial and market conditions since 2008, there appears to be a chronic mismatch in the advisor and client investment horizon. Telling clients to traditionally “hold stocks for the long run” may no longer make sense if a massive portfolio shift is required at some point. Perhaps monthly statements should be converted to one statement every five years to prevent clients from panicking.
Today’s profit pressure on wealth managers and private banks mean that they cannot think freely, truthfully facing today’s perilous market realities alongside their clients. Clients are as confused as ever. They are desperately seeking yield as their final grasp at earning anything from their portfolios. Many have abandoned equities only to pitifully watch the market rally to new highs.
Individuals need to stop comparing their investment performance to indices because the indices contain no cash; they have no lifestyle and living requirements and goals. Indices do not account for large cash draw downs to pay for your kids’ college bills. Chasing index performance actually causes you to take on excessive risk. This may work out in a bull market, but is painful when it turns against you.
Even though the annual return of the S&P 500 has been 8 per cent annually, investors in it have faced periods of significant outperformance and underperformance. And in Hong Kong, the timing of boom and bust real estate prices complicates a portfolio. Someone who began investing their savings in 1970 and working for 30 years will show a substantially different ending balance than a person starting in 1980 and working for 30 years.
So clients’ retirement should not only be based on investment outcomes, but on the high probability that their household consumption and spending habits and necessities are volatile and unpredictable.
The individual, long-term investment portfolio must be constructed around simple financial standards. This includes: capital preservation, a rate of return sufficient to keep pace with the rate of inflation, return expectations based on realistic objectives (the market does not smoothly compound annually at 10 per cent or 6 per cent).
Lost money can be earned again, but not lost time. Today’s portfolios need to be tightly constrained around time frames. Developing a portfolio with a 10 year investment horizon when you only have five working years to retirement will probably create a disappointing outcome.
Peter Guy is a financial writer and former international banker