Financial Services

One Year Anniversary

/ Kiwi Investor / Leave a comment

Kiwi Investor Blog is one year old.

My top three articles for the year would be:

Investment Fees and Investing like an Endowment – Part 2

Endowments and Sovereign wealth Funds lead the way in building robust investment portfolios in meeting a wide range of challenging investment objectives.   This Post covers this and amongst other things, what true diversification is, it is not having more and more asset classes, a robust portfolio is broadly diversified across different risks and returns. A lot can be learnt from how Endowments construct portfolios, take a long term view, and seek to match their client’s liability profile. Although fees are important, an overriding focus on fees may be detrimental to building a robust portfolio and in meeting client investment objectives.

 

A Robust Framework for generating Retirement Income

This Post builds on the Post above and looks at an investment framework for individuals, developed by EDHEC-Risk Institute and their Partners. It is a Goal Based Investment framework with a focus on capital value but also delivering a secure and stable level of replacement income in retirement.

 

The monkey paw of Target Date Funds (be careful what you wish for)

This Post emphasises the need to focus on generating a stable and secure level of replacement income in retirement as an investment goal and highlights the approach that is required to achieve this. Such an approach would greatly enhance the outcomes of Target Date Funds. This Post also references the thoughts of Professor Robert Merton around having a greater focus on generating replacement income in retirement as an investment objective and that volatility of replacement income is a better measure of investment risk, as it is more aligned with investment objectives, unlike the volatility of capital or standard deviation of returns.

 

Kiwi Investor blog has covered many topics over the year, including the value of active management, the shocking state of the investment management industry globally, Responsible Investing, the high cost of index funds and being out of the market.

Of these, recent research into the failure of the 4% rule in almost all markets worldwide is well worth highlighting.

 

Kiwi Investor Blog has a primary focus on topics associated with building more robust portfolios and investment solutions.

The Blog has highlighted the research of EDHEC-Risk Institute throughout the year. EDHEC draw on the concept of Flexicurity. This is the concept that individuals need both security and flexibility when approaching investment decisions. This is surely a desirable goal and the hallmark of a robust investment portfolio. The knowledge is available to achieve this and the framework and rationale is covered in the Posts above.

Flexicure is my word of 2018.

 

I don’t think the Uber moment has been reached in the investment management industry yet. Technology will be very important, but so too will be the underlying investment solution. The investment solution needs to be more tailored to an individual’s investment objectives.

As outlined in the Posts highlighted above, the framework for the investment solution has emerging and is developing.

It is a goal based investment solution, more closely tailored to an individual’s investment aspirations, so as to provide a more secure and stable level of replacement income in retirement.

 

Happy investing.

 

Please see my Disclosure Statement

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Shocked to see the State of the Asset Management industry

/ Kiwi Investor / Leave a comment

“The asset management industry is at the crossroads of enjoying rising markets and growing pools of capital to manage, and navigating significant disruption, changes and pressures from all sides. Taking the right path and making the right choices to adapt, evolve and transform will distinguish winners from losers.”

That is the thoughts of KPMG following the publication of report in to State of the Asset Management Industry

KPMG have identified three game changes that they believe are “fundamentally changing the landscape for this industry. How the asset and wealth management firms respond to these will likely determine their success in the next 5 -10 years.”

KPMG identify three main Game Changers:

  1. ETFs
  2. China
  3. Responsible Investing

 

Responsible Investing

The focus on Responsible Investing (RI) was interesting and a little concerning.

KMPG notes the global asset management has a lower level of trust than the banks and insurers. This is a big issue for the industry.

Therefore KMPG calls for the industry to “truly embrace responsible investment and embed Environmental, Social and Governance criteria into the investment process”

KMPG see this as an important part in restoring trust within the industry. They encourage the “industry to be much more wholehearted and convincing in embracing responsible investment and embedding ESG factors into the investment process.”

“The next generation of retail, pension fund and institutional investors want to see their capital being used to create an impact and contribute to a better world”.

 

Of course Responsible Investment and ESG are not new. The Responsible Investment Association of Australia (RIAA) was set up in 2002. Australia has likely lead the rest of the world in this respect.

Therefore, a key issue is that Asset Managers, and Asset Owners, can clearly demonstrate to clients and regulators they are doing what they say they are doing, a point noted by KPMG. A more convincing approach is required.

 

The other two changes are well understood, ETFs and China.

ETFs

KPMG note:

  • Exchange Traded Fund (ETF) assets are already bigger than hedge funds and index tracker funds, and are expected to overtake mutual funds within the next 10 years. Currently the global ETF market is at US$5 trillion and is expected to more than double in the next 5 years.
  • There are rapidly growing markets where ETFs are the vehicle of choice. They fit well with digital technology used by Roboadvisers. They work well as efficient building blocks for asset allocation solutions and model portfolios in the wealth management industry and in the increasingly important self-directed market.
  • Wealth Managers are increasing their use of ETFs. Areas of growth include smart beta, while active ETFs are increasing in popularity

KMPG sum it up: “The traditional asset management industry is at an inflection point. Regulatory scrutiny around value for money and transparency, disruptive D2C technology and new investor preferences, necessitate that firms adapt and innovate if they are to flourish in the new order.

 

China

Pretty simple, “KPMG expects the industry to grow at a double digit rate, year on year, over the next 15 years.”

“In 1998, six Fund Management Companies (FMCs) managed US$1.27 billion, while today 132 firms manage US$2.0 trillion of funds. KPMG forecast USD$5.6 trillion of assets under management in China by 2025, which would make it the second-largest asset management market in the world.”

 

It is certainly a challenging environment for which industry leaders need to be aware.

 

Happy investing.

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Please see my Disclosure Statement

Is the 4% rule dead? – Approaches to Generating Retirement Income

/ Kiwi Investor / 6 Comments

The 4% rule of thumb equals the amount of capital that can be safely and sustainably withdrawn from a portfolio over time to provide as much retirement income as possible without exhausting savings.

Bill Bengen developed this rule in 1994.

There have been numerous other studies since and the rule has gained wide acceptance.

Essential to these studies is the expected returns from markets. By and large previous studies have been undertaken using US Equity market data.

Nevertheless, this raises several key questions: are returns from the US representative of other country’s expected equity market returns? and will the historical returns generated in the US be delivered in the future?

 

The 4% rule has been challenged in a recent article by Wade Pfau.

Pfau has expanded the research to include other developed nations (17 in total) and lengthening the analysis to 30 – 40 years.

Pfau concluded:

  • the 4% real withdrawal rule has simply not been safe;
  • even with perfect foresight, only 4 of 17 countries had a safe withdrawal rate above 4%; and
  • a 50/50 allocation to bonds and stocks had zero successes for the 17 countries.

 

At a minimum, investment outcomes can be improved from:

  • Increasing levels of portfolio diversification e.g. the use of alternatives;
  • A dynamic asset allocation approach that adjusts withdrawals to market conditions; and
  • An appropriate rebalancing strategy.

 

Pfau’s article is well worth reading, he concludes “It may be tempting to hope that asset returns in the twenty-first century United States will continue to be as spectacular as in the last century, but Bogle (2009) cautions his readers, “Please, please please: Don’t count on it” (page 60).”

 

The most insightful observation

In my mind the most important insight from Pfau’s study was that safety of generating retirement income does not come “from conservative asset allocations, and the findings from this figure suggest that from an international perspective, stock allocations of at least 50 percent during retirement should be given careful consideration.”

I say this given the sharp reduction in equities by many Target Date Funds and many Target Date Funds have limitations, see a recent post and another I posted earlier in the year.

 

More robust and innovative retirement solutions are required

We are living longer, and the concept of retirement is changing. New and more sophisticated investment solutions are required.

Thankfully the investment knowledge and approaches are available to provide a safer and sustainable level of retirement income.

These new strategies are based on Goal Based Investing, drawing on the insights of Liability Driven Investing (LDI) approaches employed by the likes of Insurance Companies and Defined Benefit plans.

The new generation of retirement investment solutions involve a more goal-based investment approach and something more akin Target Date Fund 2, which involves the adoption of a more sophisticated fixed interest solution.

 

EDHEC-Risk Institute

From this perspective I like the EDHEC-Risk Institute framework which places a greater emphasis on generating retirement income.

EDHEC argue investors should maintain two portfolios:

  1. Goal-hedging portfolio – this replicates future replacement income goals
  2. Performance-seeking portfolio – this portfolio seeks returns and is efficiently diversified across the different risk premia – disaggregation of investment returns

 

Over time the manager dynamically allocates to the hedging portfolio and performance seeking portfolio to ensure there is a high probability of meeting replacement income levels. There is no predetermined path. Investment decisions are made relative to increasing the probability of achieving a level of retirement income.

The Goal-hedging portfolio is a sophisticated fixed interest portfolio of duration risk (interest rate risk), high quality credit, and inflation linked securities. Nevertheless, investment decisions are not made relative to market indices nor necessarily a view on the outlook for interest rates and credit, they are made with the view to match future replacement requirements, matching of future cashflows. This is akin to what Insurance companies do to match their future liabilities (LDI).

The investment framework developed by EDHEC has intuitive appeal and is robust in the context of developing an investment solution for the retirement challenge. It looks to address the shortcoming of many Target Date Funds.

 

The EDHEC framework is a more efficient framework than the rule of thumbs that reduce the growth allocations towards defensive/income, and the income component is invested into market replicating cash and fixed income portfolios.

Nevertheless, and most importantly, the Goal Based Investment framework outlined by EDHEC focuses on the right goal, replacement income in retirement. The industry, by and large, has a too greater focus on accumulated wealth.

Accumulated wealth is important, but more importantly will it deliver the required replacement income in retirement.

 

In summary, the retirement investment solution needs to focus on generating a sufficient and stable stream of replacement income in retirement. This goal needs to be considered over the accumulation phase, such that hedging of future income requirements is undertaken prior to retirement (LDI), much like an insurance company does in undertaking a liability driven investing approach. Focusing purely on an accumulated capital value and management of market risk alone like many of the current Target Date Funds may lead to insufficient replacement of income in retirement for some investors.

Lastly, and not least, a good advice model is vital and technology also has a big role to play in the successful implementation of these strategies.

 

Happy investing.

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Please see my Disclosure Statement

The Market Fox interviews a Wise Owl of the Australian Investment Industry

/ Kiwi Investor / Leave a comment

This is worth sharing, a Podcast interview by Daniel Griolio with Jack Gray, an Australian investment industry veteran.

This is a great interview for those new and old to the industry.

 

Although Jack is wise, he is not silent like an owl.  Jack is well known to many within the industry for his forthright views, okay strong opinions.  Which is great, we need more of this to challenge the status quo and to have intellectually honest debates.  Not to make things more complicated but to challenge some of the industry practices.  Jack touches on the downside of holding strong beliefs and being willing to share them in the Podcast, it comes with a cost.  It is who he is, he calls out if he believes things are wrong.

Jack joined the investment industry later in life after a career in Academia, he talks about how he had to learn things from scratch, there are some great insights here e.g. what advice would you give to a young Jack Gray starting out?

The interview is wide ranging and Daniel does a great job keeping it flowing, with lots of good discussion, stories, and introspection.

Topics include:

  • thinking about probabilities;
  • heuristics;
  • you don’t need a lot of maths to be comfortable investing;
  • IQ vs temperament in investing successfully;
  • the short term focus of the industry;
  • industry agency issues;
  • investment firms learning to play to their strengths and being different;
  • IA; and
  • Robo Advice.

 

Happy investing.

Please see my Disclosure Statement

 

Global Investment Ideas from New Zealand. Building more Robust Investment Portfolios.

 

Factor Investing Portfolio Construction

/ Kiwi Investor / 2 Comments

Following on from my last post on Factor Investing this article provides some good insights into the implementation of a factor portfolio.

The article makes a few key points:

  1. The best way to capture the different factors is through diversification i.e. diversify across the different factors: value, momentum, size, minimum volatility and quality. Avoid having a single factor exposure.
  1. Although factors work, their performance vary greatly given different underlying financial and economic environments (macro environment).
  1. It is difficult to pick when the macro environment will change to the benefit or otherwise of an individual factor. Therefore, successfully under or over weighting a factor to expected changes in the macro environment offers little value add.  It is nevertheless likely to be more fruitful than making country and sector allocations shifts based on anticipated changes in the macro environment.
  1. There are a number of approaches to constructing a factor portfolio. Most often implemented are equally weighted approach (i.e. equal allocation to each factor) and risk weighted approach.  Risk weighted, in simple terms, starts with an equally weighted portfolio, then reduces the portfolio allocation to the higher risk factors e.g. more volatile factors, and increases the portfolio allocation to the less risky factors (in practice this is a more sophisticated and technically advanced approach).  Whichever approach is implemented, it needs to be consistent with Investor’s risk appetite and investment objectives.

The implementation of a robust factor portfolio is more complicated than outlined above.  There are a number of nuances that need to be considered e.g. level of portfolio turnover and redundancy of portfolio holdings i.e. a portfolio holding could enhance one factor but dilute another factor exposure.

 

Finally, the article makes a key point, this applies in any portfolio, robust portfolio construction is the key to success in Factor Investing.

True portfolio diversification isn’t easy.  Many portfolios have lots of asset classes, this does not mean they have more diversification.  See More Asset Classes Does not Equal More Diversification, the failings of diversification.

A more robust portfolio is achieved through factor allocation than say sector allocations, so long as there is a broad set of factors to invest in.

 

Please see my Disclosure Statement

US Equity Market 9 Years of Advancement

/ Kiwi Investor / 1 Comment

The US equity market recently celebrated 9 years of advancement without a bear market (a Bear market is defined as an equity market decline of greater than 20% from its peak).

This 9 year Bull market is closing in on the historical record of 9 years and five and half months.  The longest post-war Bull market stretched from 11 October 1990 to 24 March 2000.  To break that record the current Bull market will have to continue until the last week of August 2018.

The US equity market experienced a “correction” in February 2018 (a correction is defined as a fall in market value of between 10 and 20%) on inflation and higher interest rate concerns.  I wrote about this in this blog and also put into historical perspective here and here.  

 

Bull markets end with a Bear market.  Bear markets usually coincide with recession.  Very rarely has there been a Bear Equity Market without recession.  Nevertheless, there have been bear markets without a recession.

Fortunately the global economy has good momentum and recession does not look imminent. Most economic forecasts are for economic growth throughout 2018 and into 2019.

Albeit, the current Bull market does face some risks.  Key amongst those risks are:

  • Earnings disappointment in 2019. Earnings momentum is vulnerable this late in the economic cycle
  • Economic data disappoints – global equity markets are priced for continuation of the current “Goldilocks” economic environment, not too hot and not too cold.
  • Inflation data surprises on the upside
  • Policy mistake by a Central Bank given the extraordinary policy positions over the last 10 years of very low interest rates and Quantitative Easing, e.g. US Reserve Bank needs to raise short term interest rates more quickly than currently anticipated
  • Longer term interest rates rise much higher than currently expected

 

Therefore, lots to consider as the year progresses.

 

I enjoyed this quote from Howard Marks “there are two things I would never say (since they require far more certainty than I consider attainable): “get out” and “it’s time.”  It’s rare for the market pendulum to reach such an extreme that views can properly be black-or-white.  Most markets are far too uncertain and nuanced to permit such unequivocal, sweeping statements.”

Well worth thinking about when making portfolio investment decisions.

 

Please see my Disclosure Statement

More Asset Classes Does Not Equal More Diversification

/ Kiwi Investor / 10 Comments

The Failings of Diversification.

Diversification has been the central tenant of portfolio construction since the early 1950s.

Diversification simply explained, you don’t put all your eggs in one basket.

Nevertheless, technically we want to invest in a combination of lowly correlated asset classes. This will lower portfolio volatility.  (Lowly correlated means returns from assets are largely independent of each other – they have largely different risk and return drivers.)

The article highlights that more asset classes does not equal more diversification.

“This is because the investment returns of a range of asset classes are driven by many of the same factors. These can include: economic growth; valuation; inflation; liquidity; credit; political risk; momentum; manager skill; option premium; and demographic shifts.

So while investors have added a range of asset classes to their portfolio (such as property, infrastructure, distressed debt, and commodities) their portfolio risk remains similar at the expense of adding greater complexity and management cost.”

 

These are key messages from earlier blogs, focus on true portfolio diversification so as to ride out the volatility and on Liquid Alternative investment strategies.

 

From the Article

Key Points

  • Diversification is just one risk management tool, not a comprehensive risk management solution.
  • Multiple asset classes won’t lower portfolio risk when the same factors drive each asset classes’ investment returns.
  • Diversification cannot provide protection against systematic risk, such as a global recession, when all major asset classes tend to fall in unison.

Risk comes in many forms but investors are acutely aware of two: the impact of capital losses and extreme bouts of volatility.

Both can have a devastating impact on a portfolio.

Capital losses, such as we saw during the global financial crisis, may never be recouped by some unlucky investors. Meanwhile, volatility can prompt investors to withdraw their money at just the wrong time or quickly erode a lifetime’s savings when an investor is drawing down their capital.

Investment Mistakes to avoid

/ Kiwi Investor / Leave a comment

In an earlier post we talked about the short volatility (VIX) products that had added to the recent global equity market volatility.

 

The experience of these products prompted a good article from Barry Ritholtz, Five Rules to Help Avoid Investing Disaster.

The Inverse Volatility Products will enter history along-side CDO’s. It is likely that 95% of the wealth invested in these Products will be wiped out when they are finally wound up/terminated.  Well worth following developments here.

 

I am somewhat bewildered from an investment strategy perspective why these exposures would end up in Portfolios at this time. It is a prime example of chasing historical returns. It is always a good idea to be guided by value.  The cost of buying volatility protection was very low. Therefore there was no value shorting market volatility, as these Products did. It is also a good idea to have a counter-cyclical bias in your investment approach: when markets are at historical extremes, i.e. historically low volatility, it is a good idea to reduce the exposure to that market extreme. Markets revert from extremes toward averages – often violently as we have recently witnessed.

This is basis of portfolio risk management and consistent with focusing on managing risk rather than trying to time markets and chase historical returns. I think most of the funds management industry was working out how to go long volatility given the over-brought nature of the global equity markets in January, not short it!  Some form of market correction was widely anticipated, the timing was just unknown.

 

Anyway, ………… the rules outlined to avoid making investment mistakes:

  1. Avoid new products – if they are a good investment no need to hurry – e.g. the Buffet rule in relations to Initial Public Offerings (IPOs)
  2. Learn from history – markets are volatile never get complacent – Hubris before the fall
  3. Never buy anything you don’t understand – another Buffet rule
  4. I would say get good investment advice i.e. wholesale products vs retail product comments, in fact considerable value can be added to client portfolios in this area and costs reduced by accessing appropriate investment strategies not readily available
  5. Greater returns always comes with greater risk – this is a fundamental axiom of investing, never forget it.  If it is too good to be true, it probably is.  There are never “easy” sustainable returns in investing.

 

Happy investing.

 

Please see my Disclosure Statement

 

Value of Investment Advice and Technology

/ Kiwi Investor / 1 Comment

I thought this was a well written and balanced article about the role of technology within the Financial Advice Industry.

The Uber moment has not really arrived in the financial services industry, particularly not in New Zealand (we have had a few cheap cabs join the ranks!).

The appropriate use of technology and mass customisation of investment solutions is the Uber moment in financial services industry.

The customisation of investment solutions involves a Goal Based investment approach, based on the principles of Liability Driven Investing.

A winning outcome will be the combination of smart technology and smart customised investment solutions.

 

Please see my Disclosure Statement