‘The Share Market Gold Rush: Prospectors and Pan Sellers’ (our contribution to The Markets and Money last week) delved into the raison d’etre of the funds management industry.
In a nutshell, the funds management business is about managing funds. The best type of market for fund managers to prosper in is a ‘raging bull share market’.
Investors eager to participate in the ‘share gold rush’ pour money into the multitude of equity products on offer – thereby providing an increasing amount of funds to manage.
The following graph (from last week’s article) shows how the financial sector profits soared with the raging bull market of 1982 to 2000. A 14 fold increase.
On the other hand, a red hot residential property market is useless to the funds management industry; they cannot build a residential property product to capitalise on the flow of dollars into this asset class.
You will also notice that when the residential property market is in favour, the economists employed by the investment institutions issue ‘research’ suggesting the property market may be fully valued.
Yet when the share market is on fire, the same economists release ‘research’ indicating why the stock market is fairly valued and has scope to move higher. Odd.
The fund management business is BIG business. High profile firms – Colonial First State, MLC, AMP, BT etc. – are valued in the billions of dollars.
The level of fees generated ultimately determines the value of a fund management business. The greater the fee revenue, generally the higher the business value.
Therefore it should come as no surprise to you that the name of the game is to attract and retain funds under management, irrespective of prevailing market conditions.
The product development and marketing departments of the institutions work overtime trying to tap into the prevailing social mood.
- When markets sustain a sizeable correction and the mood sours it is no surprise to see products labeled Capital Protected or Capital Guaranteed hit the shelf.
- When markets run hot, margin lending and other equity based offerings are suddenly the flavour of the month.
- Investors desire income? No problem. The industry renames ‘Junk Bonds’ to ‘High Yield’ or ‘Hybrid Securities’ and hey presto you have a product with an investment grade rating paying better than term deposit rates.
- When 30 June approaches, tax savings investments are trotted out.
Whatever direction the ‘herd’ runs in, rest assured the institutions will be hot on their heels with a product.
The reason for this is obvious; without funds to manage there would be no Funds Management industry. It would be called the NO Funds Management Industry. Who knows, at the end of this Secular Bear Market we may well call it the ‘Barely There Funds Management Business’.
Everyone in business needs to make sales. The financial industry is no different.
The industry sells investments.
At the very core the basics of investing are simple:
- Fixed Interest – Term Deposits, Government Bonds, Corporate Bonds etc.
- Shares – Australian, International (Developed, Emerging Markets & Frontier Markets)
Every product is a derivative of one of these asset classes.
In order to stay relevant and attract new funds the industry must constantly re-invent the basics of investing with new labels.
BRIC (Brazil, Russia, China & India) was one such label, created in 2001 by Jim O’Neill, head of Global Research at Goldman Sachs. This ‘hook’ captured the imagination of marketing teams and investors alike.
Money poured into ‘BRIC’ products. In recent times the BRIC story hasn’t quite worked out according to O’Neill’s thesis.
The current catchy acronym is ‘MINT’ – Mexico, Indonesia, Nigeria & Turkey. These are apparently the new BRICs – at least according to Wall Street.
The ‘pan sellers’ are constantly applying their energies to create a gold rush, irrespective of whether there is ‘gold in them there hills’ or not.
Having been involved in financial planning for 27 years, my advice these days (and I freely admit to being duped by the pan sellers over the years) is to Keep It Simple Stupid. My less than catchy acronym is KISS.
Invest in the very basics:
- Term Deposits
- Precious Metals
The investment industry does not like KISS. The fee revenues are too slim.
There is nothing the investment industry marketers can do to make an Exchange Traded Fund (ETF) tracking the ASX 200 sound sexy. It is dead boring. Perfect.
Give me boring every day of the week. Over the past three decades I have seen the so-called ‘exciting’ and ‘sexy’ stuff, and rarely does it deliver in the long term.
Charles D. Ellis wrote an article in the Financial Analysts Journal titled:
‘Murder on the Orient Express: The Mystery of Underperformance‘
Here’s an extract:
‘Evidence increasingly shows that a “crime” of extensive underperformance has been committed in mutual funds, pension funds, and endowments. In a pattern reminiscent of Agatha Christie’s famous novel Murder on the Orient Express, an investigation leads to a surprising, if inevitable, conclusion: The usual suspects-investment managers, fund executives, investment consultants, and investment committees-are all guilty.‘
Having said that, there are exceptions to the rule and there are some excellent fund managers who consistently deliver above-index returns. However they are in the minority and the question you have to ask is ‘can they continue to outperform?’ There are a host of variables that can impact future returns: personnel may change; fund size become too big, etc.
Here’s a chart from Ellis’s article on how useless past performance is in gauging future returns:
In the three years prior to being ‘hired’ to manage a pension fund portfolio, the ‘soon to be hired firms’ significantly outperformed the investment managers that were ‘soon to be fired’.
In the three years following the hiring and firing, the ‘fired’ firms (the ones that had previously underperformed) outperformed the ‘hired’ firms.
Is it any wonder investing an index-based ETF is my preferred vehicle for market exposure?
Moral of the story: look past the sales pitch of the ‘pan seller’. If you do not really, truly understand what you are investing in (and believe me there is no shame in this) then do NOT invest.
Earning 4% on 100% of your money is not such a bad thing when these so-called ‘growth’ opportunities wilt faster than dehydrated plants on a hot summer’s day.
In fact you can use the industry’s marketing efforts as a contrarian indicator. When the industry comes out with a (insert whichever asset class is flavour of the month) fund (especially one that is highly geared) you should sell that asset class immediately.
As always, apply the rule of ‘caveat emptor’ and if in doubt, opt out.
for The Markets and Money Australia