Over the past five years, many clients may have been underwhelmed with the performance of their typical 60/40 or balanced portfolios. As a consequence, we're finding that the challenge facing many advisers in their annual client reviews is explaining why their clients should remain invested in a portfolio of funds that have delivered flat or negative returns over the past one to three years when other funds or strategies, including cash, could have returned more for them in nominal terms over the past six months. It is possible, though, to navigate through those conversations in a constructive and meaningful way. Here, Square Mile’s Chief Investment Officer, Mark Harries, looks at how.

COMPARING SHORT-TERM PERFORMANCE WITH LONG-TERM OBJECTIVES

It's understandably very tempting to switch to funds that demonstrate better performance over the short term of one to three years. In doing so, however, clients merely crystalise their losses by chasing yesterday’s short-term winning strategy. Bearing in mind how distracting looking at short-term performance can be, advisers must frame any short-term analysis with a client’s long-term objective. Furthermore, instead of focusing on short-term performance, it can be helpful to emphasise that history has shown it’s almost random what asset class will outperform in any given year. It is, in fact, diversified portfolios which have provided value over the long term – with much lower volatility too.

TIME IN THE MARKET VS. TIMING THE MARKET

One of the perpetual challenges advisers will always have is that, while markets do go up, the journey is also always bumpy. Those bumps not only make for difficult conversations, but they can act as excuses not to invest. In such cases, it can be beneficial to highlight to clients that there has always been a reason not to invest in any one year – whether it’s the flash crash, taper tantrums, U.S. government shutdowns or yield curves inverting. Yet, it’s when people invest and then remain invested over a long-term period of at least 5 years, that they see healthy compound returns, regardless of shock events around the globe.

ACTIVE VS. PASSIVE

When it comes to the active vs passive debate, there’s no right or wrong answer. Depending on an investor’s long-term objectives, one may be more suitable than the other, or even perhaps a blend of both. The key will be in you and your clients differentiating between a poor to average manager, and a good manager. If you can identify good managers who consistently deliver what they say they will, they will beat passive management over the long term.

That’s because there are a number of ways that highly competent, active managers can potentially add value over passive. In fixed income, active managers are more likely to be able to position portfolios according to the current economic climate. For example, they can make key calls on duration, currency, or interest rates. When it comes to equities, government support of the markets in recent years meant that passive funds were arguably able to make gains more easily than they would otherwise have done without QE. Active management, therefore, and good old-fashioned stock picking, could now become far more crucial given that Government support is no longer there and increased interest rates have made borrowing costs so much higher.

THE VALUE OF USING BOTH QUANTITATIVE AND QUALITATIVE RESEARCH

Finally, it can be beneficial to point out to clients how using qualitative and quantitative research in tandem is crucial to produce helpful insights which support well-informed investment decisions. For, while quantitative research tells us what has happened previously, qualitative research can help explain how managers may perform in different market conditions, how they may adapt their portfolios in future, and can go some way to explain their performance relative to a benchmark. As a result, there are several benefits of utilising qualitative research alongside quantitative analysis:

• A deeper understanding of a fund manager and their strategies.

• Better-informed investment decisions can lead to better client outcomes.

• Easier identification of investment funds which suit clients' needs and deliver on their objectives.

When used together, then, it can stop knee-jerk investment decisions based on short term performance figures - something all advisers want to prevent.

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