Portfolio Adviser • October 2016 • Investment Strategies

As Portfolio Adviser celebrates its 10th anniversary, we reflect back to inform our view on what challenges the investment industry will encounter in the decade to come

“Growth forecasts for Europe and Japan being upbeat, along with the US facing marginal downgrades, would indicate a global economy heading for a slowdown rather than a major correction.” This was the relatively rosy state of the world when Portfolio Adviser first went to the printing press in October 2006.

Against a backdrop of concerns about the Bank of England base rate breaching 5%, global inflation and China’s record trade surplus, were features on new, exotic absolute return strategies, the then-buoyant world of hedge funds and with-profits products.

Advertising in our first issue came from Gartmore, Scottish Widows Investment Partnership and New Star, which gave us ‘Ten reasons to diversify into commercial property’.

A decade on, and much has changed. But there are lessons we can learn from looking back that will inform the industry’s future.

Nostalgia, it is said, is a seductive liar; not quite a fibber on the scale of Mr Madoff, but the ‘once bitten’ mood of caution that has held sway since the great financial crisis is likely to remain in place for some time yet.

Last month we looked at innovation across the industry, including initiatives in emerging markets and absolute return funds. It is worth noting there was not a home for the latter until the Investment Association – formerly the Investment Management Association – created a suitable sector in 2008.

Now known as Targeted Absolute Return, the sector boasts £65bn in assets, having been the best-selling retail sector in eight of the 12 months between July 2015 and July this year.

David Miller, executive director at Quilter Cheviot, suggests it is ironic that the creation of the absolute return sector was partly a consequence of their cousins, hedge funds, failing to deliver during the tough times in 2008-9.

“Post the credit crunch, one of the things people wanted was more security of return,” he says. “They had been damaged by the market setback and fall in value of things that had been presented to them as low risk. The move was towards security and that is what created the absolute return focus.”

Miller says that while markets have been relatively buoyant in recent years, absolute return has not produced particularly good returns because the cost of insurance is extremely high in a period of low volatility.

“The costs of providing that certainty has gobbled up a significant proportion of the upside,” he says.

This raises an important point in that while the product mix has grown rapidly during the past decade, the price investors are willing to pay for funds has fallen markedly, boosting providers of passive funds.

Ian Barnard, a founder of Capital Generation Partners, says that while in 2006 around 90% of his portfolios were invested in active funds, that proportion has since fallen to around one-third.

He says: “We want cheap, effective and liquid strategies, and in the future we will be seeing a lot more low-cost hedge fund beta products. Trend following, which has been in the hedge fund world for a long time, has proved remarkably robust.”

Turning to product evolution over the next decade, Barnard points to the leaps forward made in the sophistication of low-cost funds investing in equities, such as factor investing, which have yet to be replicated in the fixed income space.

“Fixed income is still issuance weighted, with benchmarks skewed to the most indebted countries and companies,” he says. “It is still something we have not cracked. There has been a lot of academic work on understanding equity returns but less so on fixed income. There are no fundamentally weighted fixed income indices or funds.”

Attitudes to the major asset classes, especially fixed income, have undeniably been altered by record low interest rates since 2009. Demand for genuine alternatives that can deliver the twin goals of diversification and income has risen over the past decade.

Alongside the emergence of absolute return and multi-asset, traditional real asset diversifiers, such as property, continue to prove popular. While issues around illiquidity and gating of bricks and mortar funds that first occurred in 2008 was a huge blow to confidence in the sector, the reccurrence of these problems in 2016 has led to questions over the long-term feasibility of leaving these products open to retail investors.

With the regulator among those keeping a close eye on open-ended funds within the sector, Robin Johnson, head of investments, best of breed, at Nedgroup Investments, is one investor calling for big changes.

He believes the Financial Conduct Authority will follow the legislation introduced in the German market in January 2013, which requires investors in retail open-end funds to hold for a minimum of 24 months and give 12 months’ notice for redemptions.

“This has not, however, weakened the appetite for real estate and has tackled the mismatch between the potential illiquidity of the underlying asset and a desire for instant access, which is no longer an option,” he says.

“In sensible hands, and with the right vehicle, property is a good source of income as the price volatility through any cycle can be ignored by long-term investors. At retirement, if you can lock up your money for a number of years and achieve a 3.5% yield, this is very attractive at the moment compared with the 10-year European government bond or an inflexible annuity.”

But what of equities? Those who invested in the FTSE 100 a decade ago (data to 21 September), would have achieved around 70% total return, according to FE Analytics. During the same period, the MSCI World delivered 130%. Since the nadir of 3 March 2009, the return is even more impressive: 158% from the FTSE 100 and 210% for the MSCI World.

Amid the fashion for ‘capital protection’ and ‘volatility dampeners’, it is still hard to pin down the raging bulls of risk assets.

For Mark Dampier, head of research at Hargreaves Lansdown, we are in the throes of the “most hated bull market” of a lifetime. He says: “The past 10 years has been unbelievable. I have never seen clients so non-euphoric. They are suffering from a ‘macro disease’ in that they are worried about every event. No one is revelling in the bull market and making more money, and half of investors have more money in cash.

“They were scared out in 2012 because of the eurozone crisis but the FTSE 100 market has gone from the low point of 3,600 to 7,000, and the FTSE 250 has done way better. But lots of people have missed out on this because they spent too much time worrying about asset allocation, led by the passives.”

Still, Dampier acknowledges asset allocation today is harder than it has ever been because most assets are “overpriced”.

“There has been massive central bank manipulation with financial repression on a scale never seen. But is it likely to end well? I would be bearish on that because, at some stage, there will be problems that will make 1929 look like a tea party – but not just yet.”

He says: “I would love to see euphoria from the clients as that is the warning sign that we are six months from a major fall. I could, of course, be wrong this time; history rhymes but it doesn’t always repeat itself.”

In considering the past 10 years, and more so our future as an industry, there must be a mention of the bliss and burden of regulato-ry change. While some legislation has been met with outrage – Fatca, anyone? – changes brought about by the Retail Distribution Review have been met largely with open arms since 1 January 2013.

From a chief executive officer’s perspective, Mike Webb of Rathbone Unit Trust Management says the past decade has been defined by a shift from selling products to an environment influenced by RDR and the suitability regime.

According to Webb, this has led to greater professionalism in portfolio construction to meet investor outcomes. He says: “The same influence has resulted in the rise of holistic financial planning to accommodate the emphasis on individual responsibility for financial welfare.”

Referring to the issue of costs, Webb says greater transparency and the concentration of buying power has driven down pricing in the asset management arena, though he adds this “is yet to generate similar pricing pressure in the advice market”.

Looking to the next 10 years, he says: “We should continue to see these trends play out, with continued pricing pressures and emphasis on outcome-orientated investing, particularly as the new pensions freedoms really take hold.

“There is likely to be a greater use of passives to reduce the total cost of investing, with active management providing alpha around core portfolios. We will see far greater use of digital strategies to improve the customer journey. Meanwhile, one can only hope the industry finds a solution to the advice gap.”

Catering for clients in the wake of pension freedoms and making advice more attractive and accessible to a larger part of the population are the two greatest opportunities, and steepest challenges, now facing our industry. Here’s to 2026.

. Since 2008, the IA’s retail Targeted Absolute Return sector has become home to £65bn in assets.

. Greater transparency and the concentration of buying power has driven down prices in asset management.

. Investors are arguably in the throes of the most mistrusted bull market in history.