The Wealth Room

South Africa has experienced good returns across nearly all asset classes for some time. Currently, investors are faced with the reality that we are now
entering a difficult (normal) time, in which targeted returns are under performing relative to their average over the long term. Clients who have expectations(substantiated by good returns and even periods of above-average returns) of consistent positive performance may feel uncomfortable by the current situation. During periods of uncertainty, many clients panic and question whether they should remain invested or switch to a better-performing fund. This reactive behaviour is emotionally charged. Your role as financial planner is to manage your clients’ expectations to help them avoid emotional investment decisions and stick to their long-term financial plan.

WHO IS STUCK – YOU OR YOUR CLIENT?

A discussion around investment performance includes looking at the performance of the particular funds and more importantly, both your and your clients’perceptions of relative or poor performance. It is also important to have a clear understanding of your clients’ expectations and what they want to achieve by investing in specifics funds, before assessing performance.

As you know, most clients would like to achieve the best possible returns at the lowest possible risk. It is important to explain to them that higher returns also require higher risk (or volatility). Clients often don’t understand their tolerance to risk and rely on you to guide them in this respect. In such cases one will often find that aspects such as the expected targeted range of returns and whether the client has a long enough time horizon and/or sufficient assets to take on the risk associated with the selected portfolio or strategy, were not adequately established at the inception of the investment.

Inevitably, during periods of negative or lower-than-expected returns clients question the value they receive from their planners and the fees associated with advice.

It is important for you to get a good understanding of your client’s background, current situation and future goals. You need to identify the best strategy and risk allocation to achieve your client’s desired outcomes.

SO HOW CAN YOU HELP YOUR CLIENT?

The first step is to make sure that you understand your client’s goals. The next step is simple: does the client understand the basic investment principles that influence the way in which their money is invested? This conversation relates to aspects such as diversification, the expected range of return, time horizon for achieving returns and the likelihood of negative returns from a specific portfolio in real terms, as well as the impact of consumption on capital. Couple these factors with the impact of market volatility and how this is mitigated within the selected portfolios by the fund managers. Once all of these are addressed, it is important to establish whether the current relative and perceived performance is still bound. Through these types of conversations, you are engaging with your clients on a level that adds value and meaning; mentoring clients to help them understand what their investment strategy entails.

These meaningful conversations will empower you and your client to determine whether the experienced behavior toward risk (or periods of negative returns) is cause for concern. At this point, you can look at the underlying funds and determine the expected range of returns and time horizon of the associated fund or funds. This way it becomes easier to make an informed decision on the way forward, instead of being emotionally reactive. In the end, the primary objective is to determine whether the selected portfolio is still appropriate to help clients achieve their financial goals.

BREAK THE CYCLE OF EMOTIONAL INVESTING

Below are some strategies for managing your clients’ emotions:

1. The bucket system. Parking the client’s income requirements in cash or enhanced income funds – therefore, securing the income over a specified
period (one to three years) – gives the rest of the portfolio the opportunity to ride out the period of volatility, associated with a growth portfolio, in
earlier years of investment. This strategy may simply change the timing of the disinvestment’s from the equity market and there is no guarantee that
you can time it better, so you have to be clear on the purpose of this approach. If your goal is to provide your client with security in times of
uncertainty, this should be your primary motivation and not trying to time the market.

2. Hedge funds. This asset profile does not correlate in the same way as traditional asset classes like cash, bonds, equities or property. It aims to
optimise returns created by inefficiencies that are associated with volatile market conditions. The view is that hedge funds reduce risk and provide
higher returns over the long term. This strategy requires specialist knowledge because of the complexity of hedge strategies and their appropriateness
to your clients’ overall investment strategy. Hedge funds are not generally available to retail clients and therefore you have to be equipped to make
an informed recommendation on the additional risks associated with them. Aspects such as restricted liquidity and gearing could materialise with
unintended consequences for the client.

3. Absolute return funds also use alternative strategies and serve as a measure to contain risk over the long term.

4. Guaranteed annuities or a combination of a guaranteed income and living annuity is another way to reduce emotional burden (specifically where a client is not able to tolerate any risk or want to secure the income that they need to live on).

5. Using statistics to demonstrate the consequences of reactive behaviour by realising a loss is another way to manage emotional decisions. Discussions including recovery trends in negative markets, asset class returns over time and Dalbar studies on timing the market can help your client to make an informed decision.

Once you and your client have gone through the above process of continuous conversation and discovery, they should be able to deal with negative
performance in a meaningful way.