• Stonewood AM


The age old agency problem seems to play an unexpected roll in investment advice. A financial advisor aims to give clients the best investment advice possible in order for the client to have the highest probability of achieving their goal. The client assumes by definition that the advisor is acting in his best interest at all times. A fair assumption to make.

So let’s go through some of the decisions that the advisor needs to make in order to determine the correct investment. First and foremost there is the financial needs analysis and risk tolerance assessment that needs to be done for every client. This will lead to a blue print for the advisor from which he can make informed investment decisions on the client’s behalf.

There are still a few other decisions that need to be made at this point namely which investment vehicle or wrapper is appropriate for the client and his investment goal and followed by that what actual investment portfolio needs to sit into this investment vehicle. This is obviously a gross over-simplification but let’s not try an complicate things for the purpose of this discussion. This is obviously a gross over-simplification but let’s not try and complicate things for the purpose of this discussion.

The investment portfolio decision is in the end the most critical decision but also the most difficult, as over time this will determine the outcome of the client’s investment return. (Assuming reasonable fees, no penalties etc.) The most critical decision however is also the one for which the advisor is under the most scrutiny. Most investors, despite their perceived tolerance for risk, are in fact risk averse. In other words, human beings are more likely to dislike losses, more than they enjoy gains. There is an asymmetry in the utility they derive from the experience of a gain versus that of a loss. This is however all very theoretical because one only ever knows this difference in utility when you in fact experience such a loss.

The financial advisor understands this and therefore knows he has a big incentive not to put a client in a situation where his risk aversion instinct will override his understanding of investment volatility and long term investment outcomes. What this means in practise is that advisors tend to avoid volatility because it makes it far easier to keep a client invested and happy in a lower volatility portfolio despite the lower long term investment outcome. To a certain extent there needs to be sympathy for advisors in this context because at least by keeping a client invested, the outcome is likely to be better than that of a client either sitting in cash or constantly changing investment portfolios.

Yet the long term outcome of most client portfolios is jeopardised by this conflict of interest, because most clients simply are to conservatively invested. Over a short period this won’t make a massive difference but over the long run the compounded difference between a more aggressive and a more conservative portfolio is catastrophic.

The advisor, by protecting the client from himself, is also adding to the likelihood that you, the investor, will never achieve your investment outcome. The one way to achieve this is to break the link between selecting portfolios based upon short term performance. This is sadly unlikely as despite years of evidence that this should be avoided everyone still does it. In such a competitive advisory industry, if one does not yield to the investor/client’s demands and desires, you as an the advisor are as quickly replaced as an investment fund is changed.

The system has it flaws, of which many are documented. System aside, the advisor needs to take the high road and ensure that the investment portfolio selected for clients is in fact suited to the investment outcome and the investors risk tolerance as opposed to what will keep the client happy. At the same time the client needs to be made aware of the flaws in their decision making process.

Too many clients are to conservative in their retirement portfolios because of short term risk aversion. This needs to be corrected because long term underperformance is almost guaranteed by this suboptimal decision making.

Local Market

ALSI closed the week flatter, inching 0.06% higher. Industrial stocks gained 0.22%. Local markets were supported by better than expected economic data as well as the US Fed announcing that they will be keeping the target range for interest rates at current levels. The Top 40 blue-chip companies on the local bourse closed 0.07% lower. Resources showed their resilience, closing the week 0.25% higher. Financials posted a weakly loss, retreating 1.18% amid heightened fears of the bond sell-off that rating decisions might trigger. Geopolitical issues continue to fill local headlines as South Africans prepared to celebrate Freedom Day, markets were closed on Wednesday last week to commemorate 22 years of our country’s first democratic elections

Global Market

The FTSE posted a 1.09% drop, while the Dax and Eurostoxx followed suit shedding 3.22% and 3.59% respectively. European markets as a whole followed global markets lower, with slight trepidation about the confidence in recent rallies led by commodity producers. Brexit concerns remain an additional headwind faced by British and European investor confidence. US markets had a bearish week with the Dow Jones closing 0.84% lower. The broader S&P closed 1.26% lower, while the tech-heavy NASDAQ sustained the heaviest losses to close the week 2.67% lower. Tech companies posted disappointing earnings albeit somewhat expected given global market conditions. It seems as though investors got a head start on the “sell in May and go away” mantra. The Hang Seng closed the week 1.86% lower. The Japanese Nikkei fell 5.16% after the Bank of Japan (BOJ) kept interest rates unchanged, investors were expecting further monetary easing, and however a recent finding suggests that the BOJ is now a top 10 holder in 90% of its own country’s stocks.

Economic News

The Rand closed weaker against its major European counters, however continued to strengthen against the US Dollar, closing the week 1.18% stronger. President Zuma suffered yet another legal blow with the High Court ruling that he should face the corruption charges brought against him, adding to the Rand’s strength. Commodities experienced a bullish week with gold posting a 4.89% rise and oil gaining 6.69%. Gold miners continued firmer, while oil traded higher on expectations of declining production levels and increasing global demand. Oil is not 34.63% up YTD but remains incredibly volatile. Dollar movement and global growth expectations are wreaking havoc with the price over and above the normal supply and demand disagreements between the various oil producers. They were also further boosted by Dollar weakness as the US economy looks a little less convincing as earning season continues. Data showed the US economy grew by 0.5% in the first quarter of the year, lower than the expected 0.7%, manufacturing data is due for release next week. Local economic data showed that South Africa recorded a trade surplus of R2.95 billion in March, a first for the 2016 financial year.

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