Canadian investors want it both ways

Opinion

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This article was published 07/10/2017 (2899 days ago), so information in it may no longer be current.

Investors want it all, it seems. That’s what a recent survey of those with assets of at least $100,000 indicates.

Natixis Global Asset Management’s 2017 Global Survey of Individual Investors suggested that Canadian investors expect annual returns on their portfolio of about 10 per cent… over inflation and after fees.

Queue the laughter.

Perhaps at one time, that was the expectation for returns. But if you talk to most industry professionals these days, they are apt to say you’re lucky to get six per cent a year after fees, but not inflation, on a consistent basis.

Curiously, the survey also indicated that more than eight in 10 investors favour safety over performance. While there were plenty of other numbers to mull over in the survey, these two points say a lot about the mind of the average investor.

On the one hand, investors have investment-return expectations that entail taking on significant risk. At the very least, their portfolios would have to be heavily oriented to stocks. That being the case, the chance of incurring large losses is elevated. On the other hand, they want safety — and that often involves investing in government bonds and GICs. These days, after accounting for inflation, you are lucky to make any material profit.

So investors, it seems, want to have their cake and eat it, too. But this is an imaginary cake, in all likelihood.

The findings, however, aren’t all that surprising to Natixis’s head of research, Dave Goodsell, because they reflect the fact that most investors are average folks.

“One of the things we have to recognize is that people live their lives and their focus is not managing their $100,000-plus assets they have,” the executive director of Natixis’s Durable Portfolio Construction research centre said.

“They have jobs and families — and I would assume they have do not spend 100 per cent of their day running their assets.”

That’s where advisers prove their worth.

“Investing is someone’s part-time job and they need and want someone who is a professional to help figure things out, full time,” he said.

Indeed, some of the data mined from the study bear this out. Most people trust their adviser over every other source of investment information.

“We call financial advisers ‘client therapists,’” Goodsell said. “They are helping them define their goals in monetary terms and working with them to see how they’re doing relative to those goals.”

Then again, the study also pointed to investors fearing the managers in charge of their money were closet indexers. In other words, they worried the additional fees they are paying for investment advice may be wasted because their portfolios don’t outperform their benchmarks. That being the case, some investors probably wonder whether they should instead buy an index fund that passively tracks the performance of, for example, the TSX Composite.

Again, Goodsell said this is understandable. A good argument can be made for investors to use passive strategies that are low-cost — particularly for the Canadian and U.S. stock markets dominated by large companies.

The problem is many people assume too much from indexing strategies. And they can be shocked that when markets plummet, so too does the value of the investments.

“The truth is that it can’t give you downside protection because while indices will give you market returns when they go up, they also have no risk management, so they’re going to give you the losses when markets go down, too,” he said.

Goodsell said good advisers help investors protect themselves. They build portfolios that can actually fulfil those seemingly duelling needs of strong market returns and safety.

“We call that durable portfolio construction,” he said. “It’s thinking about portfolios in terms of how they weather ups and downs.”

In many ways, the game has changed. It’s no longer sufficient for investors once they accumulate a sizable amount of treasure to stick with bonds, cash and stocks. Institutional investors recognized this many years ago. They have been steadily putting money into hedge funds that use alternative strategies.

“The hedge fund industry has grown a lot from its early days,” said Mike White, portfolio manager for Picton Mahoney, a hedge fund company that offers products available to investors of all sizes.

The term “hedge” is ancient.

“Roman farmers used to plant hedge rows to protect crops from weather, and the origins of the word are very true to its meaning,” he said.

By around 1960, “Alfred Winslow — considered by most to be the grandfather of hedge fund investing — wanted to protect clients’ portfolios from the vagaries of the market,” White said.

“Fast-forward a few decades, and the hedge fund industry has evolved to include not just those authentic hedge managers, a camp we put ourselves into.”

Today, hedge funds also include more performance-oriented strategies, like the one run by George Soros.

Their primary goal is “to achieve eye-popping returns.”

It’s those funds that garner the most media attention — like the fund managers who bet against the U.S. housing market in 2008, as described in detail in Michael Lewis’s book The Big Short. Bernie Madoff and his Ponzi scheme that defrauded billions from investors also likely come to mind.

But hedging in its true sense is all about downside protection, said Phil Mesman, portfolio manager of Picton Mahoney’s Tactical Income Fund.

“The business case for hedging has never been stronger,” he said.

Consider fixed income, or bonds. Yields are low and interest rates are rising.

This is a conundrum for retired investors who need income. They don’t earn much from bonds, but at least the income is steady.

Yet as rates rise, the value of their bonds will fall, and if they want to sell them and buy higher-paying bonds, they face losing money on that transaction.

Because of the challenging landscape, managers are more and more using alternative techniques, which at one time never would have been allowed in the mandate of a mutual fund — like buying put options for government bonds to protect against losses in the face of interest rate hikes.

Increasingly, investors understand the need for alternative strategies, the Natixis survey also found.

More than 85 per cent of respondents want to better balance of risk and return.

“They want insulation from volatility and better diversification — and want returns that are less tied to the broad market,” Goodsell said, adding 45 per cent now invest in alternatives, which can include hedge funds.

“So investors get it, but what they need are advisers who can explain what an investment is, what risk and reward it offers, and above all, why it’s in their portfolio in the first place.”