By Nigel Whittingham, Director, Square Mile Investment Consulting & Research

Nigel WhittinghamThe age old practice of selecting funds based on peer group performance, over time periods which are largely meaningless and which is proven to be of absolutely no use in predicting future performance, is under significant pressure, both from the regulator and investors– and about time.

Added to this, the Regulator in the UK is very exercised about investors investing in funds which provide appropriate outcomes. To understand the drivers of change in the retail investment market, Square Mile Investment Consulting & Research conducted a detailed piece of research.. The insight from the results has provided some very clear conclusions.

Investment outcomes

Investors do not understand, and are not interested in spurious investment benchmarks. They are looking for more "personal benchmarks" or clear outcome driven investments that meet their specific needs. This trend is well established in the US.

It is far more relevant to establish whether a fund’s stated objective is appropriate for the investor, and then to consider whether the manager can consistently deliver to that stated objective. In a world driven by investment outcomes, the fund’s objective becomes crucial, as it forms the basis of the “contract” with the client.

The research unsurprisingly identified the following investment outcomes as the most important for investors.

Capital Accumulation.

The increasing cost of retirement provision for individuals has become a major factor for the state and employers over the last decade as the responsibility for, and the risks associated with, retirement provision have shifted from the state to the individual.

In the process of capital accumulation, a focus on risk management relative to financial objectives and existing provision has become important, with regulation  supporting this. In addition, and linked to risk, it is a widely held view that funds and investment solutions that provide for the accumulation phase need to be more specific, outcome focused (target return/date or inflation protection etc.), in order to provide a greater understanding of realistic expectations so crucial in the planning process.

The current ubiquitous risk driven solutions in the funds and model portfolio worlds are testament to the way in which accumulation is currently being addressed in an outcome driven world. The definition of risk in the risk based solutions (predominantly volatility) is an area which needs further thought and development resulting in a broadening of the definition and measurement of risk in a way which more accurately reflects how investors understand risk.  

The search for income - decumulation.

The focus here is principally when investment income must replace workplace income. There are a number of factors at work.

The "baby boomers" who dominate the nation's wealth are retiring and will therefore need income investments. There is a “wall of money” looking for income here. The Bank of England estimates that 70% of the wealth is held by those age 52 and above.

Low returns from currently favoured low to near zero risk investments (government bonds and interest bearing accounts) exacerbate the problem. These are favoured as they are (mis)perceived by investors as low risk, neglecting the effect of inflation, and because of the experience of the credit crunch and its subsequent repercussions.

Investors need to take on and manage risk as part of income generation and management, given increased life expectancy and longevity in retirement. This is a complex business where expertise and advice are often required.

As is the case in the accumulation phase, there is a widely held view that funds and investment solutions need to be more outcome specific (target income, risk, inflation). This again ties in with the trend towards "personal benchmarking", particularly crucial for retirement income planning.

Things to be considered by practitioners and the developers of investment propositions are different income requirements - higher income, lower but growing income, income linked to inflation, volatility of capital. It quickly becomes evident that evaluating an income fund solely in total return terms is of limited value, and an understanding of the manager’s commitment to a clear income objective and the fund’s income track record, is really important.

Preservation of capital / de-risking.

With "baby boomers" retiring, and the significant amount of capital they control being required to provide income, preservation of capital has never been more important. However increased longevity and the effects of inflation mean that preservation and growth of capital and income are the long term requirement.

Investors, as they take responsibility for their own retirement provision, need to transfer the risk that they take on from the state and employer to financial services providers. Needless to say there is a lack of trust by investors here based on poor experiences with various financial services providers.

This article first appeared in March's issue of Portfolio Adviser