Avoid information overload to make good investment decisions (afr.com)

Make meaningful changes to your portfolio

Investment performance is tricky in bear markets, particularly when bonds, equities and property are underperforming simultaneously. In major downturns, the investment focus can quickly shift from return on capital to the return of capital. Getting good advice and making meaningful changes to your portfolio are crucial in preventing major drawdowns in your wealth.

Intuitively it makes sense to adjust your position over the business cycle. The idea that volatility and drawdowns are irrelevant is simply lazy portfolio management, particularly if your mantra is capital preservation. Never forget that it takes a bigger percentage increase to recover lost capital (a 25% drawdown requires a gain of 33% to recoup your original capital). It does not matter if you are private investor running your own investment portfolio or a professional investor managing significant capital for others capital – you need to adjust your portfolio across the cycle as the landscape evolves.

John Maynard Keynes said, “When the facts change, I change my mind – what do you do Sir?”

Despite the already considerable falls in equity markets this year, the economic backdrop is deteriorating further, and investors should remain cautious. Further falls of 10-20 per cent in global equities are a decent probability. After years of ultra-stimulatory policy across Western countries, inflation has moved from ‘transitory’ goods prices and is now spilling over into stickier services, food, and shelter prices. Central banks across the globe are adopting contractionary policy settings to limit the rise in inflationary expectations and slow down the pace of aggregate demand. The risk of recession is rising, which could lead to further weaknesses in equity prices as consensus earnings and multiples reset lower.

The ease of access to financial information, online brokers and low fee market index funds as seen a significant rise in the number of self-directed private investors. Running your own portfolio allows participants the freedom to make their own decisions and build portfolios that better reflect their preferences and risk tolerance while saving on fees. However, managing your own portfolio, particularly on a part time basis, does come with considerable challenges including gaps in market knowledge and a lack of due diligence on opportunities. Dealing with the psychological pressure of getting things wrongs can be tough and making mistakes, including falling for frauds, can be extremely costly. The discipline to sell equities at a loss when the circumstances change is not something that is always present when managing your own money.

But where do investors get good advice?

There is no shortage of information being packaged as financial advice. Fund managers from across the risk spectrum are targeting direct to consumer channels with glossy marketing collateral - all with products promising superior returns. It is incredible how many investment strategies are best in class and expected to consistently beat the market. In an attempt to better protect consumers from inappropriate sales, regulators introduced last year new product design and distribution obligations (DDO) requiring firms to design financial products to meet the needs of consumers and to distribute their products in a more targeted manner. The fear was that the industry was relying on a lack of knowledge and not aligning the risk profile of products with that of their investors.

Unfortunately, financial advisers have not covered themselves in glory either. The advice industry has taken a massive reputation hit over recent years, with many famous organisations being forced to compensate clients for poor advice or fee-for-no-service. The quality of the investment skills of advisers within the industry has been challenged and there has been increasing efforts to lift education and training standards. Monthly publications taking 1 per cent tilts against benchmarks that hold 85 per cent in equities do little to protect capital when the strategic asset allocation is going to significantly underperform their investment goal. Individual investors will often make much bigger portfolio changes but have a tendency to be driven by emotion or passion rather than insight and often at precisely the wrong point of the cycle.

Just like the home renovation market, there are many that will adopt a do-it-yourself (DIY) approach and those who will rely on professionals to plan and execute a job. You might tackle a few tasks around the house but the electrical work you leave to professionals because the risks of getting it wrong are so much greater. Knowing what to do with all the information available and taking meaningful portfolio action is the skill worth paying for. Unfortunately, you do not really know you if have a good adviser until you actually meet one.