This probably makes asset managers uncomfortable, but shouldn’t. Recent developments have also made this question easier to answer, and a productive way to build trust with potential investors.
Moreover, think about this: do you prefer the alternative? Namely, ‘What aren’t you telling me about how this is going to lose me money?’
Taking a step back, and perhaps looking to the recent ISA deadline, haven’t we all wondered one of these two questions ourselves? In which case, financial advisors and fund selectors will be asking the same. Can this be any different for those with the weight of a whole pension scheme on their professional shoulders? Or investment consultants, with their own reputations on the line?
It isn’t negative to consider such a question, and indeed such behaviour is linked to our psychology; people tend to have a greater reaction to a loss than the exact same gain.
This reaction is also logical, if you consider that markets are documented to correct faster than they progress. Most fundamentally, and regardless of the speed of any decline, investment has always meant risking a loss. Individuals and institutions are prepared for that – and want an open discussion about it. If someone asks the elephant-in-the-room question, the only honest answer is that any investment could lose you money. But how do you explain this?
The rise of tracker products and factor investing has actually made such explanations easier, to at least some degree. The relative simplicity of such products in simply following the benchmark up or down means that losses are quite explicitly built in and as a result explainable. This is particularly pertinent as we approach after the apparent end of a decade of bull markets, which will impact these types of funds.
The understanding of different factors has also spread a further acceptance of the inevitability of periods of underperformance. For example, ‘growth’ stocks are understood to perform relatively poorly when the overall economy is not growing, whereas ‘value’ strategies should act more defensively in such scenarios but may underperform during periods of particularly strong market exuberance. Separately, investors now widely understand that ‘low volatility’ strategies should in theory give fewer surprises (both good and bad) than a certain benchmark.
These terms and a more nuanced understanding of different kinds of risks can only helpful for investment managers.
The even longer-established concepts of investment management work in a similar way too. Active managers tend to talk about ‘alpha generation’ so frequently because it’s their USP compared to the implied negative of ‘beta’, which is to say the correlation between a given strategy and wider market volatility.
Investment risks are perhaps also better understood now than ever before, meaning easy answers and ‘no-downsides’ arguments will be rightly treated with suspicion. It’s also easier than ever before to analyse – and explain – the situations in which an investment may have periods of under performance.
This is actually an advantage for investment managers, but one they must take advantage of. Clear explanations of the possible pitfalls of a particular approach are critical to ensure investor understanding and need to be proactively communicated if managers want to build long term relationships. Only then can discussion get back to the main question asset managers want to answer; namely: what defines your investment strategy?
