The industry needs a fresh approach to portfolio construction and a new commitment to educating investors, writes Natixis Global Asset Management's Matthew Shafer.
As concerns mount over the health of UK savers’ retirement pots, a lack of confidence in markets is threatening to make things worse.
According to a recent survey we undertook, for 70% of those profiled, market volatility is undermining their ability to reach their savings and retirement goals and eroding their expectations for future investment returns.
The health of the UK economy is one of their top concerns. The majority (93%) said they were concerned with the UK’s financial standing, followed by global uncertainty (91%) and lingering European debt issues (85%).
So, where are investors looking for help? Nearly three quarters (73%) believe their own home is a better investment than the stock market, leaving savers unprepared in the event of a drop in housing prices. In the event of their retirement funds falling short, 40% said the government (and the taxpayer) will fill the gap and 19% plan to rely on their children.
Investors are conflicted: 67% are torn between protecting their capital and pursuing returns, with 80% saying they would focus on safety if forced to choose. The result is that cash is king, even in the face of record low interest rates, with 86% planning on either maintaining or increasing their cash investments.
A real solution depends on re-building investor confidence, getting them invested in the markets and keeping them there long enough to reach their goals.
To get there, we need a new approach to portfolio construction that helps investors stand up to modern market challenges – an approach that puts risk first, not returns. We need to focus on managing volatility, incorporating non-correlated and alternative asset classes, and pursuing smarter traditional fixed income and equity strategies.
The market volatility of recent years has exposed the traditional 60/40 approach to asset allocation as outdated. Volatile equity markets have increased portfolio risk and bonds have been unable to deliver decent streams of income.
Investment markets continue to be dominated by global event risk. Market events, including the recent US fiscal deadlock and uncertainty over Fed tapering, have led to rising correlations across asset classes.
Investors agree. Nearly two thirds (64%) said a traditional approach to their portfolios is no longer the most effective way to access returns and manage risk.
Furthermore, 68% said they would consider alternative investments if their adviser recommended them, highlighting the role an adviser can play in helping investors to diversify their portfolios.
In terms of how this new approach to portfolio construction plays out in practice, there are a number of building blocks investors should consider:
Risk: Risk, not return, should be the primary driver of asset allocation. Risk has historically been more stable and, therefore, a more predictable variable than return. By placing risk at the centre of portfolio construction, investors are able to target a consistent range of risks as opposed to a potential range of returns. This allows them to combine investments that seek to reduce overall risk, with others that pursue return more aggressively.
Smarter use of traditional assets: Investors should also look to make smarter use of traditional asset classes. High conviction equity and fixed income strategies can offer attractive opportunities, as they sit in both the alpha and beta camps.
By incorporating risk budgeting, they are able to generate sufficient returns at appropriate levels of risk.
Diversifying via alternatives: Diversification is crucial. In today’s highly correlated market environment, investors should be incorporating alternative investments, which are uncorrelated from the broader market, into their portfolios, in order to temper volatility and pursue new sources of return.
Encouragingly, 77% of UK investors say they are interested in alternative investment products unrelated to the performance of the broader market.
UK investors are not on track to reach their goals. To get there, they need to overcome uncertainty and fear, and get invested for the long term. That is not going to happen with the same outdated approaches to portfolio construction that suffered large losses during the crisis.
We need a new approach to portfolio construction and a new commitment to educating investors about how to use it. The adviser community is the key to bridging that knowledge gap.
Investing for retirement is a long-term game. By working with advisers to build more durable portfolios, investors can seek to overcome the market noise, stay invested and provide for the retirement they expect.
No preferred charging model
To 1,552 families and businesses
HL and Liberty SIPP slowest
Lifetime and annual allowances