 |
|
|
|
|||||||||||||||
 |
||||||||||||||||||
|
||||||||||||||||||
|
|
|||||||||||||||||||||
 |
||||||||||||||||||||||
The Traditional Investment Advice ModelRedefining Investment Advice 1Redefining Investment Advice 2Redefining Investment Advice 3Our job as an Investment AdviserThe NLFM Model For Investment AdviceThe NLFM Delivery Model For Investment AdviceFurther InformationThe Traditional Investment Advice Model
As a financial planner, you regularly encounter the following situation. You meet a stranger who asks what you do for a living. When you tell them that you’re a financial planner, they immediately ask what shares you like, where you think the market is going, or whether you know the name of a fund manager - the next Anthony Bolton— who knows such things. These people have taken to heart the message that most of the City has conveyed for decades: giving investment advice boils down to making a forecast. They want a planner to look into a crystal ball and predict the future.
But do you really believe that you are well-served by this type of advice? You owe it to yourself and your family, to consider another approach - one that makes no predictions but that uses principles grounded in academic finance. You should avoid the risk of speculation, and instead benefit from the intelligence and stability of an approach based on solid theory and empirical evidence. To Top
The reason is simple: capital markets work. Investing is not a zero-sum game where one investor must lose so another can win. Any investor has the chance to capture the same capital market rates of return. Over the long run, markets reward investors with positive returns for taking risk and providing capital. If they did not, the capitalist system would have collapsed long ago.To Top
Redefining Investment AdviceThe City’s prevailing definition of investment advice is not the only one. A different definition has developed in the academic world based on decades of empirical research. The new approach culminates with the work of the academics. Eugene F. Fama of the University of Chicago’s Graduate School of Business, author of the efficient market hypothesis, is widely regarded as the “father of modern finance”. Kenneth R. French of the Tuck School of Business at Dartmouth College is an expert on the behaviour of security prices and investment strategies. Together, Fama and French have provided two anchor points for our definition of investment advice: market efficiency and the risk dimensions of shares and bonds.To Top
Market Efficiency Markets work. Prices reflect the knowledge and expectations of all investors. Although prices are not always correct, markets are so competitive that it is unlikely any single investor can routinely profit at the expense of all other investors. There is no free lunch - the only way to get higher returns is to take more risk. Markets are drawn to a long-run state of equilibrium where risk and return are related.To Top
Dimensions of Equity Returns Fama and French’s analysis of the sources of investment risk and returns has reshaped portfolio theory and greatly improved the industry’s understanding of the factors that drive equity performance. These three factors are: Equities market: Equities have higher expected returns than fixed interest. Company size: The shares of smaller companies have higher expected returns than the shares of larger companies. Company price (measured by the ratio of company book value to market equity): Lower-priced “value” shares have higher expected returns than higher-priced “growth” shares.To Top Redefining Investment AdviceThe notion that equities behave differently from fixed interest is widely accepted. Within equities, Fama and French find that differences in share Because they are riskier, financially less-healthy “value” companies have higher costs of capital than financially healthier “growth” companies. When they borrow from a bank, value companies pay higher interest rates; likewise, when they issue shares, they receive lower prices. A company’s cost of capital is the investor’s expected return. Small value companies, therefore, have higher expected returns than large growth companies. Long-term increases in expected returns can only be achieved by accepting greater small cap or value risk. The three-factor model defines risk with a precision that has made it the modern research standard. Size and price characteristics, along with broad equities market exposure, are the major explanatory variables in equity returns.To Top
Can You Beat the Market? If markets are not efficient, then the brightest and hardest-working fund managers should be able to beat a simple buy-and-hold strategy over time.To Top
Before fees, the track records of traditional managers are similar to what would be expected from a room full of orangutans throwing darts at share and bond listings. After fees, the expected distribution of results is better for the orangutans because they are assumed to work for bananas. —David Booth, Dimensional’s Co-Founder, “Index and Enhanced Index Funds”, 2001. Nearly forty years of academic research has shown that traditional investment managers are unable to outperform markets by anything more than the amount we would expect by chance. The first landmark study of professional managers was conducted in 1968 by Michael Jensen, now of the Harvard Business School. Jensen analysed the performance of all US funds from 1945 to 1964. He documented that managers were not able to outperform the market in a statistically meaningful way.1 In later years, a multitude of studies reached the same general conclusion: the average actively managed fund does no better than the market after fees, transaction costs, and taxes. It should come as no surprise that active managers fail to beat the markets. For managers to succeed consistently, markets must consistently fail.To Top
Adjusting Returns The illustration below shows a distribution of alpha significance - a risk-adjusted measure of manager performance. The shape of the curve is what we’d expect by chance. When fees and expenses are subtracted, the results are “skewed” to the left (lower than the randomly expected outcome).
 .
The idea that any single individual without extra information or extra market power can beat the market is extraordinarily unlikely. Yet the market is full of people who think they can do it and full of other people who believe them. . . . Why do people believe they can do the impossible? And why do other people believe them? —Daniel H. Kahneman, 2002 Nobel Laureate in Economics. Redefining Investment AdviceFrom a practical point of view, investors are probably better off if they just assume that markets are efficient. It will save them the distraction of wondering whether this fund manager is better than that one. —Rex Sinquefield, Dimensional’s Co-Founder, 1997. An Identifiable Skill in Advance A famous Fidelity fund manager in the US, Peter Lynch, provides us with interesting anecdotal evidence. He retired in 1990 after serving as portfolio manager of Fidelity’s Magellan fund for thirteen years. For the thirteen years since his retirement (J Even if Lynch’s success is due to skill, Magellan’s later results suggest that it’s a skill not easily defined or passed along to others. Active skill is only useful to you if you can identify it in advance. Lynch had the power to choose a highly qualified successor and train him thoroughly. Even with this advantage, one of the greatest share-pickers of all time could not seem to identify a great share-picker in advance.
Our job as An Investment Adviser
What would our role as planner be within the new definition of investment advice? In the old definition advisers try to forecast investments. In the new definition we capture capital market rates of return. Riskier capital market segments generate greater returns, so it’s crucial to consider our client’s risk preferences. By asking specific questions about how you would cope with good and bad market conditions, we can help you to identify how much risk that you can tolerate. Then we can use this information to structure your portfolios in a way that effectively achieves those risk exposures.To Top We break the process down into five key parts: diversification, client education, discipline, cost, and a holistic approach.
Diversify Your Portfolios Clients should invest across a range of asset classes that are most appropriate for their individual goals, time horizon, and tolerance for risk. As asset classes behave differently from one another, each plays a different role in a portfolio. The whole is greater than the sum of its parts: clients can achieve greater expected returns with lower risk in a diversified portfolio. Asset allocation and a diversified portfolio are crucial.To Top
Educate Your Clients Clients should have a clear understanding of how markets work and how to capture market returns. Our job is to help our clients understand that forecasts don’t work and are generally costly. By educating our clients, we help them act on intellect instead of emotion. An important part of this job is “playing defense”, by educating our clients on what to avoid. History is littered with examples of products that have sold well, but whose risks have not been sufficiently spelt out and investor wealth has been destroyed.To Top
Maintain Discipline While asset pricing scientists have identified the factors that explain over 90% of equities performance, a big wild card for individual investors is discipline. Investors will not effectively capture market returns if they abandon their long-term strategy in response to recent events or predictions of the future. Most of the City (and the media in general) promotes a short-term perspective that is diametrically opposed to the principles of modern portfolio theory. Helping clients maintain discipline is a difficult but important challenge that can make or break their portfolio. The foundation of this discipl
Keep Costs Down and Reduce Taxes Markets are uncertain, but you can always control investment costs and taxes. By reducing these whenever possible, you help your clients retain a greater share of their investment return.To Top
Take a Holistic Approach Our clients are much more than their investment portfolios. To help them meet their long-term financial goals, we need to know them as people, and we should acquire an understanding of their human capital and non-investment financial challenges (such as estate or tax planning issues). A holistic approach is at the heart of the new model for delivering investment advice.To Top
The NLFM Model for Investment AdviceFees, Not Commissions In the old model, commissions were payments for one-time transactions. There is no place for them in the new model. What if the best advice is not to trade at all, but to buy and hold a diversified portfolio? In this case, the commissioned salesperson cannot earn a living by giving the best advice. Furthermore, with varying levels of commission and payouts for financial products, commissioned salespeople will always face a conflict of interest. They may not exploit the conflict, but it exists nonetheless.
The NLFM model calls for planners to receive a fee for advice. This ensures that our interests are aligned with your interests. Planners have every incentive to give their best advice. The client-centred financial planners of the NLFM model spend their time very differently. We talk to clients, respond to enquiries, reassure when necessary, and meet with them in person. This is not to say that they are not concerned about investments, only that they do not allow investments to overshadow their client relationships. In fact, the very nature of the NLFM model frees planners to spend more time with their clients and strengthen the bonds of trust. The traditional model vs. the NLFM model. Putting client needs at the top of the decision ladder is a fundamental change in a client’s investment experience. Rather than hope that a financial Adviser sells them an appropriate solution at the right time, the NLFM model assures that the client always gets advice that protects their investment.
The NLFM Delivery Model for Investment AdviceThe NLFM model for investment advice turns the old model directly on its head. The customer is no longer at the bottom of the business relationship, with a large financial services firm at the top driving investment decisions. The client is now at the top of the process.
The NLFM model requires a new set of goals and a new way of thinking.
The NLFM investment model offers advantages for both clients and planners. Clients are much more inclined to stay the course and meet their financial goals. They get what they really want - help in making wise financial decisions. Planners effectively differentiate themselves from the competition. They worry less about short-term markets, free from worry that their predictions won’t come true. Increased career satisfaction comes from giving clients your best advice with an investment approach grounded in economic logic and years of empirical research.To Top
Please click below for a recommended website for further information |
||||||||||||||||||||||
returns are driven by company size and price characteristics. Taken together, the three factors explain more than 90% of the variation in average equity portfolios.
une 1990 to March 2004), Magellan returns were equivalent to broad index returns (see side bar graph).
ine is education.