Tuesday, April 27, 2010

Hard Sells, Harder Lessons

Jim Parker, Vice President, DFA Australia Limited

Sometimes you need to see the worst practices of the financial services industry to understand why it is worth paying for good advice. Take, for instance, what's been happening in New Zealand.

Huljich Wealth Management is an accredited distributor of KiwiSaver, a voluntary work-based savings initiative set up by the New Zealand government to encourage Kiwis to grow wealth for their retirement.

The Securities Commission launched an investigation into Huljich after the company's founder, principal shareholder and managing director Peter Huljich admitted he propped up the fund with his own money in 2008.

Huljich later admitted his wrongdoing and resigned as managing director and chief investment officer. While the firm insists no member lost money as a result of his actions, the controversy has hurt the company's reputation.

At the same time, the Securities Commission has expressed concern over aggressive marketing techniques by distributors of KiwiSaver, including high pressure door-to-door selling and inducements to sign up right away. Huljich is alleged to have been one such aggressive marketer.

"The commission has become aware of a number of circumstances where KiwiSaver membership has been solicited in an unusual or confusing manner. This type of behaviour is completely unacceptable and damaging to investor confidence," commission chairwoman Jane Diplock said.1

According to one newspaper, Huljich sold the superannuation scheme to two intellectually disabled students who had little idea what they were signing. One was under the legal age and the other had a reading age of 8.

In some cases, investors did not know they were committing to KiwiSaver. Some thought they were purchasing household products. In other cases, inducements were offered for long-term membership. Some people were even offered the chance to win a $100 shopping voucher if they signed up.

The controversy over KiwiSaver is not what the New Zealand financial services industry needs, as it struggles to restore its collective reputation after a series of scandals in recent years involving finance companies.
A total of $1.5 billion of investors' hard-earned savings were lost in those collapses in 2007-08, a blight on the New Zealand securities industry that the commission's chairwoman blames on a patchwork regulatory framework.2

A common theme in the scandals is a lack of understanding among the general public about the difference between an independent financial planner and a sales person for a product distributor. The latter receives incentives to sell product, while the former is paid by their clients to build a customised financial plan — including a diversified investment portfolio - designed around their individual needs, aspirations and risk appetites.

The government is now attempting to address this by putting up for discussion a draft code of conduct for authorised financial advisors, which sets minimum standards of competence, knowledge and skills, ethical behaviour and client care which advisors would have to meet.

At the core of the code of conduct is a requirement that when providing advisory services, authorised advisors must place the interests of their clients first and must act with integrity.

Advisors would not be able to characterise their advice as "independent" when they are being paid by a person other than the client or are under a contractual obligation to recommend a particular product.

Dimensional has long argued that financial advice is best left to independent and professional advisors who are directly familiar with their clients' financial experience, risk tolerances and individual goals.

The relationship between Dimensional and advisors is not tainted by commissions or other incentives. Rather, it is founded on shared ideas about how markets work, a joint commitment to education and a common goal in ensuring clients have a good investment experience.

The investment philosophy is also a sound one. No market timing or forecasting or speculation is involved. It is not about fickle fashion or ego-driven claims by individuals about being able to "beat" the market.

Instead, it is about working with the market to build diversified portfolios around risks that rigorous research shows are related to return. It is about keeping costs as low as possible and about being mindful of taxes. And it is about staying disciplined.

There are no hard sells in this view of the world - just an unchanging commitment to the welfare of the individual investor.

1'NZ Commission Warns KiwiSaver Funds', NZPA, March 24, 2010
2'The System is Broken: We Need to Fix It', Jane Diplock, NZ Herald, March 26, 2010

Wednesday, April 14, 2010

Mission Impossible

 Jim Parker, Vice President, DFA Australia Limited

It's a Hollywood staple. A group of ragtag desperados is assembled to embark on a suicidal mission — think 'The Dirty Dozen' and 'The Magnificent Seven'. It makes for exciting viewing, but applying this approach to investment isn't recommended.

At the height of the bear market in early 2009, Australia's BRW magazine, a popular weekly business title, asked 50 market experts to draw up a roadmap for the anticipated recovery, including the best sectors and stocks to buy.1

The panel of 50 participants comprised fund managers, equity strategists, economists, analysts and other tipsters. From their recommendations, the magazine put together 18 "expert ideas" for the recovery.

The dozen and a half individual stock tips were split broadly between big, well-known, blue-chip companies such as QBE Insurance, BHP Billiton, Woolworths, Westfield, CSL and Boral — alongside some mid-caps, smaller stocks and outright speculative plays.

While couching its stock tips with a host of qualifications — nothing was certain, markets rarely followed a neat script and blindly relying on history was dangerous — the magazine said these were the pick of the bunch.

For the reader wanting to position themselves for the recovery, it might have seemed a reasonable assumption that assembling a concentrated portfolio comprising these 18 super stocks would be a good strategy.

But while parts of the magazine panel's ideal portfolio did do well — mostly the very small, speculative companies — only seven of the 18 stocks overall outperformed the wider market's near 40 per cent gain in 2009.

Indeed, many of the tried and true blue chips in the list underperformed the market. QBE Insurance gained just 5.3 per cent over the year, Woolworths rose 9.1 per cent and CSL actually went backwards, down 1.5 per cent.

If investors had assembled the BRW's 'rebound' portfolio at the start of 2009 and held each stock at its market cap weight, they would have seen a return of 26.8 per cent over the ensuing 12 months.

While that may sound great, it's worth pointing out that just by owning the broad market, as defined by the S&P/ASX 300 accumulation index, investors would have enjoyed a return of 37.6 per cent, a 40 per cent improvement on the magazine's ideal portfolio.

Holding a highly diverse portfolio of value stocks would have delivered an event better result. For instance, Dimensional's Australian Value Trust, with 187 stocks, posted a return in 2009, net of fees, of 43.6 per cent.

Holding such a broad range of companies in a portfolio is called diversification. It allows the investor to capture broad market and economic forces, while reducing the uncompensated risk arising from individual stocks.

This isn't to say you can't beat the market by assembling a focused portfolio. But these successes are usually more down to good luck than good judgement and they are very hard to repeat. It's like taking a punt on a horse.

In any case, as we've seen in the above example, even a portfolio assembled by the best and brightest can come up short of the mark. What chance, then, has the ordinary investor of generating consistent market-beating returns by relying on a handful of securities?

At the end of the day, gambling on a band of hand-picked individuals might work for Yul Brynner and Lee Marvin in the movies, but trying to build long-term wealth with a handful of stocks looks like mission impossible.

1'Waiting for the Rebound', Tony Featherstone, BRW magazine, Jan 8, 2009

Tuesday, April 13, 2010

Birthday of Thomas Jefferson (b. 13 April 1743)

 From The Writer's Almanac with Garrison Keillor

It's the birthday of the man who said: "Determine never to be idle. No person will have occasion to complain of the want of time who never loses any. It is wonderful how much can be done if we are always doing." That's Thomas Jefferson, (books by this author) born in Albemarle County, Virginia (1743). And he certainly lived by those words. He wrote the Declaration of Independence for the fledging United States and then served as its minister of France, secretary of state, vice president, and president. But he was also — among other things — an inventor, philosopher, farmer, naturalist, astronomer, food and wine connoisseur, and musician...

He loved to read ... he said, "I cannot live without books." He wrote to John Adams, "I have given up newspapers in exchange for Tacitus and Thucydides, for Newton and Euclid; and I find myself much the happier."...

He said: "In matters of style, swim with the current; in matters of principle, stand like a rock."



Wednesday, April 07, 2010

It Won't Last

Jim Parker, Vice President, DFA Australia Limited

Long-time watchers of financial markets know that investors are always worrying about one thing or another. What's not often apparent is how quickly those worries are built into prices and how rapidly the narrative changes.

The recent fretting points for investors have included, among other things, default risk in southern Europe, the threat of China's economy over-heating, the dependency of risk assets on government stimulus and the implications of proposed regulatory reforms in the international banking industry.

A rule of thumb with a lot of these hot-button financial and economic issues is that by the time you read about them in newspapers and magazines, the markets have moved onto worrying about something else.

Take Greece for example. A search on Bloomberg of the words "Greece and default" yielded nearly 300 news stories in the month of March. The subject of these articles extended from fears of outright default to, by the end of the month, news of a strengthening in the euro as Greek fears receded.

A search of the word "stimulus" on Bloomberg yielded more than 600 news articles in March, extending from Brazil's attempt to lure investors with infrastructure spending to news that Japan's retail sales were growing at their fastest pace in 13 years, thanks partly to government stimulus.

In this age of rapid global information flows, aided by web-based distribution, news is incorporated into prices almost instantly. A geopolitical development like a bomb blast in a Moscow subway, or economic news such as an agreement on a bailout for Greece or company-specific news like a Chinese firm buying Volvo from Ford….all of this tends to find its way into prices before the average person has heard that it has even occurred.

So it shouldn't be a surprise that many investors err by tinkering with their own portfolios based on information that is already reflected into securities pricing. This is like chasing a moving target or trying to catch a falling sword.
No sooner have you pondered, for instance, the implications of Y2K or the SARS virus for your portfolio than the market has decided that this issue is a flash in the pan and has gone onto worrying about something new.

A better approach is to accept that markets are extremely efficient at incorporating fresh information into prices and that trying to second guess how they might react to a particular event is a hazardous game.

By the way, one senior Australian advisor has developed a successful technique for dealing with queries from his clients about the implications for their portfolios of whatever issue happens to be dominating the financial media headlines at that time and whatever the state of markets.

"To be completely honest, I don't know what the implications are," he says. "But I can tell you this: It won't last. Now let's talk about your news."

This seems to be a healthy approach to responding to news that's dominating the markets. It's interesting, it's topical, it's forever changing and, for the most part, there is very little you can do about it.