Higher levels of market volatility, interest rate hikes and possible asset bubbles are all predicted to negatively affect investment returns this year, yet the biggest challenge advisors might face is managing clients’ emotional behaviour, according to a recent report published by Toronto-based Natixis Investment Managers Canada LP.
The Natixis Investment Managers 2018 Global Financial Professionals Survey reveals that 94% of Canadian financial and investment advisors say that preventing clients from making investment decisions based on their feelings is important to their success. Furthermore, 34% of advisors say their clients reacted emotionally to recent market movements and only 43% of advisors believe investors are prepared for a market downturn.
Financial advisors have a tough road ahead of them in helping clients prepare for financial obstacles. Specifically, advisors see rising volatility as the largest threat to the markets. Seventy-three percent say it would negatively affect overall performance, followed by asset bubbles (63%), geopolitical events (57%), unwinding of quantitative easing (57%), interest rate increases (56%), low yield environment (55%), regulation (43%), and currency fluctuations (41%).
Advisors are also wary of central bank short-term interest rate increases. Approximately 75% say this will adversely affect the housing market, credit market (71%), bond volatility (68%), overall market volatility (65%), consumer spending (62%) and economic growth (53%).
“Whether it is buying indiscriminately when markets are rising or selling in a panic when they are declining, investors often make their worst decisions when driven by their emotions,” says Abe Goenka, CEO of Natixis Investment Managers Canada, in a statement.
“Advisors have an important role to play in all markets, helping investors to be aware of the harm emotionally driven investing can cause and assisting them in dispassionately examining their goals, risk tolerance and timeframe. Our research shows they are increasingly turning to active managers for the tools and flexibility to diversify their clients’ portfolios and reduce risk.”
The majority of advisors (86%) believe that the market is better equipped to handle risks with active management. Participants in this year’s survey say they have 72% allocated to active management while advisors only allocated 68% in the 2016 survey.
“Greater sentiment toward active management could generate a further shift to active strategies, which have become essential in recent years as advisors seek opportunities to generate alpha,” the report says.
In contrast, advisors prefer passive strategies for their lower fees (56%). The vast majority of advisors (75%) believe individual investors are unaware of the risks associated with passive investing and the same number has a false sense of security around this type of investing.
Alternative investments on the rise
Financial advisors also revealed their embracing alternative investments to help moderate volatility, produce alpha and generate stable income. In fact, 66% of advisors recommend alternative investments to clients today. Their strategies include real estate investment trusts (35%), infrastructure (33%), real assets (29%), commodities (19%), hedge fund strategies (17%) and private equity (15%).
About half of advisors (47%) say investors should give an alternative strategy more than three years to prove itself.
Advisors recommending alternative investments say they see a number of liquid strategies that include
diversification, fixed-income replacement, volatility management, enhanced returns, inflation hedged, and reduced risk.
Clients need practical education
Eighty-one percent of advisors say that an extended period of higher markets has left many investors complacent about risk. And 82% say risk awareness often comes too late; investors don’t recognize a risk until they’ve suffered a bad outcome.
Based on these findings, advisors should be prepared to give much more than just investment advice over the next 12 months. According to advisors themselves, their role with clients is to guide them through emotional decisions (86%), provide ongoing financial education (71%), help in navigating life events (70%), provide guidance on identifying and achieving life goals (65%) and help with mediating family financial affairs (42%).
“Financial advisors see a world in flux in the coming years, and their ability to serve their clients will require a unique pairing of skills,” says David Goodsell, executive director of Natixis Investments Managers’ Centre of Investor Insight, in a statement.
“On one hand, they will need a firm analytical grasp of the forces driving the market in order to adjust investment strategy,” he says.
“On the other, they will need to understand the motivations of investors to avoid emotional decisions that could disrupt long-term plans. To be successful, advisors will need to be in close communication with their clients, and their advice will need to come from both the right side and the left side of the brain.”
The survey was conducted by global company CoreData Research Ltd. in March 2018. The survey included 2,775 financial professionals worldwide and 150 in Canada.