Kevin Cork warns his new clients that he is likely to rub them the wrong way at every meeting. It’s a lighthearted way for Cork, financial advisor and president of Absolute Group Inc. in Calgary, to remind those clients that his job is to help them act in their own best interests — and that often means doing the exact opposite of what their emotions are telling them.
If clients obeyed their instincts, Cork says, they would run for the hills and hide out in cash when securities prices are falling, and jump back in only when prices are on a roll.
“Emotional behavior leads to the wrong decisions at the wrong times, and that creates more damage to investment returns than anything else,” Cork says. “Our job as advisors is to help clients devise a strategy that will withstand all types of market conditions, and then help them stick to it. If we’re just order-takers, we’re not doing our jobs.”
The annual Qualitative Analysis of Investor Behavior survey conducted by Dalbar Inc. of Boston repeatedly has shown that mutual fund investors jeopardize the long-term returns offered in financial markets by moving in and out at the wrong times, and generally lag market averages. During the 20-year period between 1991 and 2010, the S&P 500 composite index earned an average annualized return of 9.1% while the Barclays aggregate bond index had a return of 6.9%. But for the same 20-year period, the average equity fund investor earned 3.8%; balanced fund investors earned 2.6%; and fixed-income fund investors earned 1%. So, the equities index outperforms the bond index — and both indices outperform investors. What are investors doing wrong?
Part of the answer is contained in the Dalbar survey, which also found that the average investor had a fund retention rate of 3.27 years, a slight improvement over 3.22 years in 2009. However, holding on for a little more than three years is not enough to take advantage of long-term cycles. No matter how well the funds are managed, inves-tors need to manage their own psyches.
“Investors diligently seek investments they hope will produce the best returns,” Dalbar president Louis Harvey writes in the survey report, “but lose much of that benefit when they yield to psychological factors.”
Paul Vaillancourt, senior executive financial consultant with Investors Group Inc. in Ottawa, says he doesn’t have to go far back in history to give clients a lesson in market behaviour. Three years ago, during the RRSP season of 2009, when markets were reacting to the financial meltdown that had begun the previous autumn, many clients were tempted to put new contributions into guaranteed investment certificates instead of capital-market investments. Had they invested in GICs, they would have missed the subsequent bounceback of almost 50% from the stock market’s lows.
“Clients have short memories,” Vaillan-court says, “but I document what happened and show people the mistake of not investing, so they don’t make the same mistake again.”
Vaillancourt also encourages clients to take advantage of dollar-cost averaging, spreading new contributions over an extended period and avoiding the agonizing decision of determining the best time to invest. He ensures that client portfolios are spread across various asset classes suitable to each client’s risk tolerance, with fixed-income and real property counterbalancing some of the ups and downs in stocks.
For Cork, if one of his clients is particularly uncomfortable with a specific geographical region, such as Europe or the U.S., the advisor may make a “sideways shift,” moving the global portion of the asset mix to a fund that is less focused in that region: “Sometimes a small shift will cure the fear without changing the plan too much.”
> Mutual Funds
“One of my criteria for choosing funds,” Cork says, “is active communication with fund managers in both positive and negative situations. I want to know what’s going on and how they are positioning the portfolio, so I can translate that for the client.”
Cork, by talking to his clients about individual companies in various fund portfolios and the reasons why they have been chosen, reassures his clients that there is a captain steering the boat.
Tye Bousada, president and portfolio manager with Toronto-based EdgePoint Investment Group Inc., is a fund portfolio manager who makes a conscious effort to communicate regularly with the advi-sors whose clients invest in EdgePoint’s funds.
“Volatility is not risk, in our minds,” says Bousada. “While short-term volatility is uncomfortable, it is not true risk. However, it causes people to do things that create real risk — like run to cash.”
With inflation at slightly less than 3%, Bousada says, any client sitting in cash at current interest rates of around 1% will be 20% poorer in a decade. That client will be losing ground even if invested in 10-year government bonds, which currently yield around 2%. And although most publicly traded companies need a strong economy to do well, the stock market provides the opportunity to find high-quality gems that can grow despite a difficult economy.
Says Bousada: “We look to buy the businesses that can get bigger even in a tough world.”
Richard Charlton, director of Charlton Group, which operates under the Dundee-Wealth Inc. banner in Oakville, Ont., reminds his clients that with well-managed funds, clients actually own shares in a carefully selected group of profitable businesses that pay regular dividend income — even when stock values are fluctuating.
“Wealth is created by investing in great companies and staying invested,” says Charlton, who often recommends Dynamic Equity Income Fund, sponsored by Toronto-based Dynamic Mutual Funds Ltd. “Some people allow the surges in the stock market to frighten them out of their investments, but they are not focussing on the fundamentals of the businesses they own. The key is for clients to think of themselves as part owners of wonderful businesses, then ignore daily price fluctuations and think long term.”
> Alternative Products
Vaillancourt often recommends Investors Real Property Fund, which provides good “portfolio ballast” because its real estate holdings are in hard assets rather than paper securities and, therefore, not subject to the vagaries of daily market valuations. That fund has shown an average annual return of 5.6% since its inception in 1984, and has had only two losing years — but even then, the fund lost less than 5%.
Other funds in that group include Great-West Life Canadian Real Estate Fund, sponsored by Winnipeg-based Great-West Life Assurance Co.; and London Life Real Estate Fund, sponsored by London Life Insurance Co. of London, Ont.
For extremely nervous clients who simply can’t sleep at night for fear of losing money, some advisors recommend guaranteed minimum withdrawal benefit products sold by insurance companies. By guaranteeing a minimum annual income based on the original assets invested, GMWB products reduce anxiety and help clients stick with the original asset allocations so they can continue to participate in the upside of equities. Most of these products offer periodic opportunities to lock in gains in asset values, creating the potential for income growth.
Bill Bell, president of Bell Financial Inc. in Aurora, Ont., views GMWBs as a middle ground for clients who want safety but can’t meet their goals with the paltry returns offered by total refuge in GICs or fixed-income. While some of GMWBs’ returns can be eaten away by the high fees — the price paid for having the guarantee — GMWBs typically offer significantly better returns than GICs, and with upside potential if markets rise.
“GMWBs are high-fee products, and getting higher,” Bell says. “But the nature of the beast is that there is risk in equities markets. And avoiding that risk comes at a price. Investors don’t know how long they’re going to live, and with GMWBs’ lifetime income guarantees, regardless of what the market does, [these products] offer income protection in case of longevity.”
John Horwood, director of wealth management with Richardson GMP Ltd. in Toronto, says some clients who had been frightened by the stock market rout in 2008 and 2009 did well by purchasing GMWBs at that time. They participated in the recovery and also were comfortable knowing a future income stream was guaranteed.
Horwood also uses long/short and market-neutral hedge funds, such as those managed by Picton Mahoney Asset Management Inc. of Toronto. These hedge funds employ techniques to offset declines in equities markets with strategies that benefit from dropping markets, such as short-selling, to create a smoother ride for unitholders.
“Clients are frightened after the events of the past few years, and the best cure is a wealth-management plan designed to withstand various scenarios,” Horwood says. “That gives clients the confidence to invest properly and stay with it rather than jumping around and making mistakes.”
Cork likes to remind his clients of past severe market declines, such as the bursting of the technology bubble in 2000, and then shows them how those crashes appear as blips on the charts showing the long-term, upward trajectory of equities’ returns.
“When everything’s going up,” Cork says, “it’s hard for advisors to differentiate themselves. But difficult markets are our moments to really shine.” IE