Three investment strategies used by the wealthy
07 October 2014
The AFR has an interesting piece on how the rich invest. It suggests that they are not all that different to the less well off. In investment, there are no definite answers, in large part because you are dealing with many other people, all of whom are also scratching around looking for answers. It is something of a disappearing point: the unknowing pursuing the unknowing pursuing the unknowing. Of course, the underlying economic and financial realities will eventually determine the price of assets, but that is always only part of the story.
The rich, it seems, choose one of three strategies:
"1. The overly wary have chosen to remain in cash or perceived cash-like investments;
2. The adventurous have cut their own paths by choosing what they like, when they like it, i.e. a portfolio of trades, rather than a true diversified portfolio.
3. The believers in portfolio diversification have decided on an asset allocation designed around return ambitions and their tolerance for risk."
There is nothing surprising or unusual about this. According to Shane Galligan, the Melbourne-based managing director of private banking at Swiss bank Credit Suisse, each group is noticing the effect of the ending of quantitative easing, or money printing, in the US.
This is how the investors who stuck to cash feel:
“They are feeling nervous they didn’t get in [to the market] to participate in the growth,” he says. They’re also on edge because hybrids and the real returns of term deposits are under pressure.
“Now, they’re all waiting for a pull-back but, overall, they don’t buy the philosophy of asset allocation. Generally this style of investor believes they’re protecting their money by being in cash and that in uncertain times, that’s where you want to be.”
However, in a low-rate environment coupled with the ongoing threat of inflation, the real returns from this approach are questionable.
Despite that, many investors remain “anchored” to their strategy. “There’s a lot of psychology involved in all this. There’s ‘anchor bias’ [where an investor relies too heavily on an initial piece of information in making a decision which then overrides any future information, regardless of merit], or someone else will tell them that cash is a good place to be, so that’s ‘confirmation bias’ and they don’t invest as a result.”
According to last month’s Investment Sentiment Indicator report from Westpac Private Bank, wealthy people have maintained an aversion to what they perceive as risky assets.
The survey of investment intentions of affluent Australians found investor focus was very much on income rather than capital growth, despite the fact the universe of credit opportunities is shrinking."
The second group of investors are spreading their investments very widely. According to Galligan they tend to take on more risk than they realise and to shy away from bonds as they don’t buy into the philosophy that bonds stabilise the risk-return profile of investing.
This type of investor tries to buy at the right time, picking individually, rather than for overall asset mix:
“They look at each asset class individually and not at how the asset performs in a portfolio context,” he says. “They can often face large, unexpected losses in poor markets, and may either increase the size of their investments to average in, or give up and become a category-one style of investor.”
The third type of approach, the portfolio method, which requires looking at the overall asset mix, is adopted by many rich investors (as is the case with fund managers who manage large funds). It very much benefits from globalisation, which allows diversification across the world:
“Having access to any asset in any currency is vital to provide the appropriate construction of a portfolio to manage risk and return,” he says.
“Investors who are believers in portfolio diversification have an asset allocation which suits their risk [appetite] and stay invested throughout the cycles. If you’re invested in an asset allocation that’s suited to you and you understand the risks, you’re probably feeling a lot less nervous [than the others].
“They take the good with the bad, so [at the moment] they’re not feeling overly anxious.”
What does this tell us? Mostly that the rich are little different from most other investors. But the rich also are less vulnerable to downturns, and can ride out their mistakes. This is especially of benefit in the diversification approach. If an investor is not forced to sell when one part of their portfolio falls in price, then, assuming they have got their diversification broadly right, they can wait for a price recovery.
This option is not really available in the highly defensive cash option. You are just locking in a minimum return. And waiting a price drop out can be a real risk in the "cheap asset picking" approach because it may be that the asset was cheap because it was a dud. So being diversified is probably the most appropriate for those who are not under pressure.