Good preparation beats trying to pick markets
10 October 2014
The dominance of the banks and insurance companies in the financial advice sector has attracted criticism because of widespread concerns over conflicts of interest. But it has another dimension, according to George Lucas, managing director of INstreet, which provides investment vehicles to fully independent financial advisers. It also means that the decision making about investment is concentrated in only a few hands.
This is of importance to SMSF investors. When they are trying to pick the thinking of the market, often that translates into speculating about what a small number of brokers and financiers in the big financial instutions are thinking.
“There is always a discussion about concentration of financial advisers but there is also a concentration of decision makers," says Lucas. "You have five or six investment committees saying ‘We are out of BHP this week, and that’s it.’ And there is no-one there on the other side. So the trades become very crowded. That is what is happening in the Australian market. So for the market as a whole it is not necessarily that healthy.
“Most advisers follow very prescriptive models. They say ‘These are our model portfolios, these are our choices.’ They are not interested in picking stocks or picking funds or whatever, they are going to rely on the big brokers, the big firms to select their asset allocation. That hasn’t been talked about at all. How the decision making about asset allocation is getting into fewer and fewer hands. There is always the exceptions, like Magellan, but you can see a problem in the small number of small hedge funds that operate in Australia.”
Lucas says savers are attracted to SMSFs because they offer more flexibility. “It is not just flexibility in determining your asset allocations (what type of assets you invest in). It is flexibility in things like controlling death benefits and insurance and estate planning. They are a lot cheaper to run now than they were five or six years ago and the prices are coming down. People do like having more control.”
It has come with a cost, however. Lucas says that SMSFs were launched when financial literacy training was little better than advice on how to use cheques. There is a big gap in understanding that has to be made up. He has launched a free web site called Wealth Know How to educate SMSF investors.
“My view is that the media give the impression that it is very easy to do DIY investing but it is not. It is just not. Everyone kind of slags off the banks for missing the GFC and stuffing up their balance sheets. At the end of the day the banks, especially the global banks, had very smart people working for them. And even they found it very difficult to manage money correctly and manage the risks.
“To think that an individual can do it better is a very arrogant approach. You will hear it in the way people get interviewed on Sky News: ‘Where do you think the market will be?’ They want an answer, as if it is a risk free environment.
“That is not really what the question should be. The question should be: ‘What is your asset allocation for the current environment not only to get the best return but also to manage the risk?’ That is the right question but that is not how individuals think. They don’t think about diversification, they don’t think about risk management. At the end of the day it is all about risk management.”
The introduction of compulsory super has been presented as a way for people to save for their own retirement, taking pressure off the pension system. That will almost certainly not prove to be the case. Most retirees will have to rely on the pension at least to some extent, and most will have to rely on it completely.
But Lucas says that was not really the main motive in any case. He says it was a trick by the government to release money in Australia’s big businesses.
“What used to happen before was you either had a defined benefit pension plan (where the income is pre-determined) and those companies had to reserve capital against the risk. A lot of capital in Australia was being tied up in companies because of these defined benefit plans.
“They said we would get rid of that and make people responsible for their own super. It freed up a lot of capital for Australia. No-one really sat down and explained to the superannuants that when the professionals managed risk they don’t do it the way you are doing it. This whole concept of saving for your retirement was never really explained.
“But corporate Australia loved it. It kind of nearly saved Westpac when they were about to go bust in the 90s. Oh, pull $500 million out of our pension plan. It is a little bit of a trick.
“It has done wonders for Australia in providing us with a big buffer. Whenever anyone talks about savings they don’t ever put super savings into the calculation. It has created a massive capital pool in Australia which people can tap into if they need to. But most people will need at some point of time rely on the pension.”
Lucas points out that what is poorly understood by non-professional investors is the need to keep reserves in order to manage risk. That is standard practice for professional investors, who know that markets can fluctuate and there must be a buffer.
“People don’t like (the subject of) asset diversification. The advisers like it. (For amateur investors) it is always about where the market will be. They don’t ask what is a good return in the current environment? At the end of the day it is the asset allocation that adds value, not the stock picking. And you also have to ask the question: ‘Why am I doing this?’ It is different if you are doing it for a day trader and planning for retirement and an asset allocation that goes out for 30 years.”