Structured products appear simple at first, but grow increasingly complex when you dig a little deeper. Hedge funds carry a certain mystery and allure about them yet often fail to deliver. Both expose investors to unknown, unconsidered or opaque risks with considerable performance and risk management challenges. Both sit uneasily in well structured, evidence-based traditional portfolios and better alternatives exist. The fact that they are widely used, does not make them good portfolio building blocks. Nor does it absolve advisers or their clients from deep due diligence, in the unlikely circumstances that they are deemed to assist in meeting long-term investors’ needs.

The paper concludes that structured products and hedge funds are smart products but dumb choices and you should tread with care.

If you would like to receive a copy of our paper please contact us at balance@bphwealth.co.uk

The article is adapted from Professor Kahneman’s latest book, “Thinking, Fast and Slow” and is an examination of the illusion of skill. Professor Kahneman was given the opportunity to examine a spreadsheet summarising the investment outcomes of 25 wealth advisers over 8 consecutive years. As he compared the first year with the consecutive years in turn to yield 28 correlations, he found little year to year consistency.

He also found that the average of the 28 correlations was .01 or zero. The outcomes were entirely down to chance not skill or judgement.

You can read the full article here

NBIM has stated that it believes that as a major global investor, it should play a role in helping to set prices in global markets. The head of the ‘Oil Fund’, Yngve Slyngstad, previously stated that as one of the world’s largest investors that they couldn’t be a freerider and leave the evaluation of what are fair prices for companies to others. When confronted with this defence of active management, Professor French’s response was to smile and dismiss NBIM’s defence with the response that if an investor wishes to engage in charitable giving through active management, that’s okay but that he wasn’t sure that it was the most effective form of foreign aid!

Whilst the debate as to passive vs active management continues (we believe this to have been clearly answered in favour of passive management), NBIM’s belief deserves serious questioning from another angle.

Jack Bogle, the founder of Vanguard, one of the largest fund companies in the world and a noted proponent of passive investment management, has stated that he believes one of the major challenges for markets today to be the lack of long-term investing. Back in the 1950′s the proportion of US equities owned by individuals was far higher than that owned by institutions. Today the situation has been completely reversed. Bogle believes that the majority of investors in the 1950s were happy to be long-term investors collecting regular dividends from their investments but rarely selling their holdings. This provided companies with a stable investor and capital base in sharp contrast to markets today where companies are focussed on the delivery of quarterly figures which impress markets and may be decisive in determining just how large executive compensation is.

It strikes us that the ‘old fashioned’ passive approach is decidedly more desirable in terms of the development of a stable economy and thus as far as society is concerned, perhaps a more stable approach. Surely given that NBIM already operates with a ‘Socially Responsible’ screening process for its investment, it should question whether its continued participation in the active buying and selling of investments goes against social responsibility and thus ought to be foregone, whether or not it feels it can generate any extra return from these activities (something which the figures show after costs it fails to do)?

We would welcome you view.

The financial markets are once again having one of their periodic panics that the financial media love to write dramatic headlines about.  These headlines cause investors to panic, with many selling their investments in, what they believe is, a flight to safety.  The reality is that the vast majority will still be scared once the market starts moving back up and will miss out on most of the rise in markets.

These fears are natural and need to be addressed.  We have devoted quite a bit of the forthcoming book to how to manage your investing behaviour but hopefully the following might provide some useful perspective.

Not all is doom and gloom

At the same time that the majority of headlines have been overwhelmingly negative the following facts illustrate that not all is doom and gloom in the world. In some areas, economic progress is being made:

• Robust Growth in Germany Pushes Prices: Analysts see a strong chance that German inflation will head towards 3 per cent by the end of the year against a backdrop of robust growth in Europe’s biggest economy. (Reuters, July, 27, 2011)
• Brazil Domestic Demand Still Strong: The Economist Intelligence Unit says economic growth in Brazil surprisingly picked up speed in the first quarter, challenging the government’s efforts to cool the expansion (EIU, July 6, 2011)
• Japan Retail Sales Top Estimates: Japan’s retail sales rose 1.1 per cent in June, exceeding all economists’ forecasts and adding to signs the economy is bouncing back from an initial post-disaster plunge (Bloomberg, July 28, 2011)
• No Fear in China: Traders betting on gains in China’s biggest companies are pushing options prices to the most bullish level in two years. The Chinese economy is projected to grow by 9.4 per cent in 2011. (Bloomberg, July 28, 2011)
• Southeast Asia Booms: Southeast Asian markets are the world’s top performers in 2011 thanks to strong economic and corporate fundamentals.  Thailand’s index hit a 15-year high in July and Indonesia’s a record high. (Reuters, July 22, 2011)
• Australian Boom Keeps Rate Rise on the Agenda: The Australian dollar hit its highest level in 30 years in late July as traders looked to the prospect of another rise in interest rates on the back of a resource investment boom. (WSJ, July 27, 2011)
• NZ Bounces Back: The New Zealand economy has grown more strongly than expected after the Christchurch earthquake, helped by improving terms of trade.The Reserve Bank signals it may raise interest rates soon. (Bloomberg, July 28, 2011)

We wrote this book because we know that many individual investors fail to obtain the returns they deserve from their finances. We want this situation to change.

• Many investors are devastated when they realise that their savings have not grown enough to meet their financial goals or even worse to enable them to maintain their desired lifestyles in retirement. They do not know where to turn for help.

• The overwhelming majority have no idea what they are paying in fees, whether the results of their investments have been good or bad or whether they are on track to achieve their goals.

• Yet more are spending hours every week reading ‘hot tips’ in the financial pages, picking individual stocks that get them precisely nowhere in the long term.

Conventional financial advice has served us badly. The financial establishment has deliberately encouraged ideas such as investing in superstar managers with ‘great’ track records, stock picking, timing the market, and jumping for the latest ‘innovative’ products. These strategies are destined to result in huge disappointment for the vast majority of investors. There has never been a more pressing need for a different approach.

Traditional approaches better serve the interests of those people manufacturing and selling the products, rather than furnishing investors with the returns they need to reach their goals.  We know from our long experience in the industry that these strategies just do not work; they consistently fail to deliver the returns we expect and deserve.

We want to break down the barriers for you, exploding the myths around finance and investment, exposing the secrets to success that the financial establishment has for too long kept to itself and provide you with the investing success you deserve.

Successful investing is about developing a process to improve your chances of a good investment experience and avoiding poor investment experiences by controlling the things you can control risk, costs and asset allocation (as you will learn in chapter 7 of The 7 Secrets of Money). 

Think of investing as a game of tennis!

In Charlie Ellis book – Winning the Losers Game he describes how Dr Simon Ramo, a Physicist, Engineer and Business Leader (sometimes known as the father of the Intercontinental Ballistics Missile) studied the game of tennis for many years. He observed that tennis is essentially played by 2 types of players, Professionals and the rest of us.  Both play using the same rules, clothing and equipment but they play 2 very different games:

• In professional tennis the result is determined by the actions of the winner who will beat the opponent by placing more precision shots just out of reach or forcing more faults from their opponent.
• The amateur game is decided largely upon the actions of the loser since precision shots and long rallies are rare and points are normally lost by driving the ball into the net, hitting it out or double faulting.  Instead of trying precision shots or faster serves, normally beyond their ability, in an attempt to become the winner the more reliable approach is simply to concentrate on getting the ball back and leave it to the opponent to make the mistakes in their attempt to become the winner.  Of course they will hit a few winners and may even look as though they might win (which will make you doubt your strategy) but as they get more confident they will make more mistakes and you will win in the long term.

Successful investing is like being that pragmatic disciplined tennis player that just keeps dinking the ball back time after time, year after year waiting for other people to make the mistakes to improve your chances of success.  Not the most exciting way to invest but investing is ultimately about achieving peace of mind that you can achieve your life goals; it should not be the source of excitement.  If you need excitement go to a casino with some money you can afford to lose not the money that your future relies on.

Remember that beating the market involves outsmarting on a consistent basis millions of participants, most of whom have far more time and resources than you and can play in different parts of the world while you are asleep.

Product distributors will shamelessly ignore all their actively managed funds that have underperformed the market and will spend huge amounts of money advertising the small number of funds that have performed well.

The industry has been attempting to convince clients to buy on the back of fund performance for as long as we have been in the industry.

Consider this example:

A fund that loses 5% a year for four years and makes 50% in year five has average fund performance of about 4% a year.

But a fund advertised as showing returns of 4% per annum over the last five years is far more attractive than a fund that has lost money in four out of the last five years.

This example might appear silly and we might reassure ourselves that we would not fall for something so obviously contrived but it is an easy trap to fall into. We advise you and advise ourselves to be cautious of all statistics and very cautious of all statistics in marketing: establish the source; check using two or three authoritative sources.

Product distributors’ aims are, like the product manufacturers’ aims, completely at odds with your aims. Product distributors will try and persuade you to purchase the products that make them the most money.

Awaken your inner cynic when it comes to financial statistics: invest with your eyes wide open

A good financial guide will help you here.

The best way to start is to ask yourself a series of questions which will start you off on exploring your life and the journey you are on.

3 powerful questions to help you uncover your goals:

Question 1: Imagine that you are financially secure, that you have enough money to take care of your needs, now and in the future: how would you live your life?  Would you change anything?

Let yourself go.  Don’t hold back on your dreams. Describe a life that is complete, that is richly yours.

The beauty of this question is that it really asks you to envision what you would like to have, be and do in your life where there aren’t any obstacles around want and scarcity.  The question enables you to put all this aside, all the things that hold us back from being, doing and having what we think we want.  In fact we are so held back that we don’t really think what is it that we want our lives to be about.  So, don’t hold back, think big and write down all these wonderful things that you want to do.

Question 2: You visit your doctor who tells you that you have only 5–10 years left to live.  The good part is that you won’t ever feel sick.  The bad news is that you will have no notice of the moment of your death.  What will you do in the time you have remaining to live? Will you change your life and how will you do it?

This time it’s best to do the exercise from the perspective of your financial position as it is now.  The question brings us into the reality that our lives are not infinite and our time on earth is limited.  Five to ten years is sufficiently long a period to accomplish a lot but also a short enough period to realise that if there are things we want to do, we should not be putting them off.

Question 3: This time your doctor shocks you with the news that you have only one day left to live.  Notice what feelings arise as you confront your very real mortality.  Ask yourself: what did I miss?  Who did I not get to be?  What did I not get to do?

This question brings us face to face with our own mortality and adheres directly to what we would want our lives to say about us.  This immediately can help us to realise what is important and what is less so and focus our attention on what we should be doing.

The importance of these questions cannot be underestimated in the context of understanding what is truly important to you.  Once these questions have been considered, mulled over and answered it is easier to look at your goals and aspirations.  This is because you are putting them in the overall and wider context of your life.

Answering these 3 questions puts you in a good position to set out on a successful relationship with money.  The answers start to give you real insight into what you would ideally do if you were able to cast off the limitations that you hold. They put you in touch with what is really important to you and the part that money plays in all of this.

[These questions were first devised by George Kinder, widely recognised as the father of the Life Planning movement: www.kinderinstitute.com.]

The smart approach we teach is based on a highly disciplined and well tested investment model backed by an overwhelming weight of academic research. And it is simple – focusing your energies on things you can control – such as saving, spending, costs, taxes and sound financial planning, only taking risks that you know will be rewarded.

This places you, the investor at the centre of the picture, firmly in command of your financial future.