In a volatile market, separating clients' emotional reaction to short-term volatility from long-term strategy is important, writes Brad Peters
Forewarned is forearmed
The US sub-prime mortgage crisis has wiped billions of paper profits from investment and superannuation portfolios throughout the Western world during the past eight months.
In Australia, the All Ordinaries Index lost more than 1000 points before clawing back some of the losses. This included a 7 per cent fall on what is now being referred to by some as Black Tuesday (22 January 2008).
For investors, this was the first serious and sustained slide since the tech-wreck and September 11 terrorist attacks hit markets with a one-two combination punch in 2001.
For many investors, the current situation was their first experience of significant downside volatility in equity markets.
Given that the mainstream media sometimes stirs panic, with the daily banner headlines highlighting billions in short-term losses, investors often turn to their financial advisers for answers and assurance.
Although investors would prefer to never see the value of their portfolios retreat, in general it appears that in 2008 clients are far less prone to panic during periods of market volatility than in the past.
Chair of CPA Australia's Financial Planning Centre of Excellence Martin Kerrigan is CEO of Snelleman Tom, a Brisbane-based firm of consulting accountants and financial planners.Kerrigan says no clients have contacted his firm specifically to discuss the state of the market, and he believes there are a number of reasons for this lack of panic.
'When we initially meet a client we are [careful] about ensuring that the client is fully aware about the various forms of investment risk, from short-term volatility to capital loss, or simply explaining that there may be periods of extended under-performance,' Kerrigan says.
'(Also) in the first round of market jitters in mid-2007 we were very proactive in running an investment seminar and getting investment updates out to clients.'
Managing director of BFG Financial Services Suzanne Haddan believes many clients had been preparing themselves for the possibility of losses at some stage.
'To some extent, I think they expected bad news after such a sustained period of excellent returns,' she says.
Haddan, whose business is located in Sydney's south-west, says in volatile times it is important to remind clients that the money they have invested in growth assets is there for the long term, and that over time the share-market had never failed to go to higher than previous highs.
Many advisers who fielded calls from clients say reaction was far less dramatic than in past periods of market correction.
Peter Tratt is principal of Melbourne-based firm Australian Wealth Advisers, which specialised in strategies for clients either at retirement or building for retirement. Tratt says many clients are now more finance-savvy after having taken an active role in building a wealth base.
'Although some clients have been a little anxious about the reductions in their balances, we have not had any clients who have been driven to alter their investment profile, or withdraw funds from the markets,' Tratt says.
'Many of our clients are retirees who are drawing income from allocated pensions. In these cases, we explain that their withdrawals are taken from their investments through all stages of a market cycle, which has the effect of averaging the withdrawals across the cycles (effectively dollar cost averaging).'
Andrew Albury is the director of Managed, a Brisbane-based financial strategy firm. He says client reaction to the softening equities market had been somewhat surprising and refreshing compared to past market corrections.
'[The clients] don't necessarily like it, but they are realistic with their expectations in that they understand there is only so much they can do about it,' Albury says.
Albury, whose firm provides tax and investment advice to small business and high-net-worth individuals, said being proactive was one of the keys to keeping your client base calm.
'Our usual approach is that we actually try to contact the client first,' Albury says. 'As long-term investors, it is generally wise for (clients) to stay loyal to their investment strategy and we spend time discussing the merits of this.'
The director of wealth planning at UBS Wealth Management David Rolleston says uncertain times always tested the strength of the client-adviser relationship.
'There are few business relationships as personal as the management of other people's money,' Rolleston says. 'In volatile times, your empathy skills and service commitment are every bit as crucial as your ability to pick stocks and managed funds.'
Steering clients away from mistakes
One of the most common and critical mistakes investors can make is to pull money out of falling markets, therefore crystallising what essentially were paper losses up to that point.
For most advisers, this is the number one mistake they want clients to avoid. Discussions at these times could be critical to the success or failure of the long-term adviser-client relationship.
According to Kerrigan, separating the long-term strategy from the emotional reaction to short-term volatility was often the key to a successful outcome.
'A client needs to decide whether the current market conditions really affect their financial goals at all,' Kerrigan says. 'For example, if you are aged 40 and intend to work another 25 years, is there really any need to change your investment profile?'
For Albury, it's important and timely to encourage clients to focus away from capital and remember the income streams produced by quality investments.
'We talk about the disconnect between the price of a share and the value of a sound and profitable underlying business,' Albury says. 'And how a quality blue-chip share will generally pay a consistent and increasing dividend regardless of the share price.
'We show the client that as long as their income needs are being met, they can afford to be a patient, long-term investor and wait for the inevitable recovery in prices.'
Haddan often reminds her clients not to spend valuable time and energy fretting about their portfolios. 'Looking at their investments too often is not a good idea,' she says.
'And thinking they or I can pick the highs and lows of the market is a big mistake.
'We spend a lot of time managing expectations, especially in the good times, where it's essential to remind clients that they will have years when investment returns are disappointing.'
Tratt also supports the need to constantly remind clients the difficulty of implementing an investment strategy that relies on successfully picking the highs and lows of a market.
'We regularly draw maps of volatile markets,' he says, 'and show how clients' returns over the long haul are a product of market volatility.'
Poor decision making by clients is not restricted only to times when the market is heading south. 'I have seen some strange behaviour in rising markets as well,' Kerrigan said.
'Often clients want to build more aggressive investment portfolios when there have been successive years of double-digit returns.
'Most notably, a client gave me the sack when his investment portfolio went up 31 per cent (index 27 per cent) because he wanted higher returns.'
Sometimes the rigours endured during down markets produced some unexpected positives for advisers.
According to Albury, advisers who were particularly conservative with client gearing strategies often received credit for steering clients through a market slide without triggering a margin call. This was especially the case if clients knew of other investors who had received margin calls.
A good adviser, Albury says, helps clients keep their gearing at a level where they would never be forced sellers. This is sometimes difficult in bull markets when all clients can see are the profits to be made by investing more.
Seizing the opportunities
There was general agreement among the advisers that market downturns were when clients would reap the rewards of following sound long-term investment principles.
One of the most popular and widely used of these principles was dollar cost averaging. This was simply a commitment to regularly adding to your investments, usually on a monthly basis using managed funds either directly or via a platform.
Haddan says dollar cost averaging works well in volatile markets, and provides clients with an assured opportunity to invest new monies at cheaper prices.
Tratt also supports the principle of dollar cost averaging, preferring to leave the stock picking to the experts.
'There are always investment opportunities in volatile markets, but we leave this to the professionals as we do not try to pick the highs or lows in the market,' Tratt says.
Albury says when markets retreat many clients look to add some strategic lump-sum top-ups to their portfolios.
'As prices are down on many quality stocks and managed investments, there is an obvious buying opportunity for the longer-term investor who has the excess cash to do so,' Albury says.
Although indiscriminate panic selling is never a good idea, Albury says sometimes market downturns also presented an opportunity to 'clean out the closet' by removing investments that may not have realised their initial potential and reinvesting into higher-quality investments that are arguably under-valued.
Kerrigan says that while there was a lot of interest in the value being offered in the direct sharemarket, he was also discovering value returning in some lower-profile areas such as bond funds and income funds that were now providing very attractive yields, some as high as 9.9 per cent.
Rolleston says volatile markets offered an opportunity for advisers to review the longer-term objectives of clients, check their risk profile, and review debt-management strategies and overweight positions for exposure to underperforming sectors.
Advisers, Rolleston says, should always understand the products they recommended and the product supplier (counter party). Volatile markets had exposed problems in this area, with some advisers struggling to explain to clients how their portfolios can be affected in the short, medium and long-term.
Brad Peters is a financial planner and deputy chair of CPA Australia's Queensland Public Practice Committee.
