Advisors believe it’s vital they diffuse a ticking time bomb of client emotion and complacency ahead of a potential downturn, according to a recent survey.
The Natixis Investment Managers’ poll asked 150 Canadian financial and investment advisors about market challenges and how they are positioning client portfolios.
It revealed that 94% believe preventing clients from making investment decisions based on feelings is crucial to their success while, alarmingly, 60% do not think investors are prepared for a major correction and 53% believe they do not understand the risks of the current environment.
A total of 75% of advisors also said clients do not grasp the risks of passive investing.
Dave Goodsell, executive director at the Centre for Investor Insight, Natixis Investment Managers, said advisors must ask themselves how much time they are spending educating clients about where the risks are in their portfolio.
He said: “This idea that advisors sees clients as not recognizing risk in their portfolio until it’s already been realized – that’s a big problem I think.
“If you combine complacency with that late tail reaction to risk, it’s important to be upfront about it and have that conversation early. We saw only about a third of Canadians react emotionally to the volatility at the start of the year, that’s a little bit lower than elsewhere around the world but that’s still a pretty large number of people looking at relatively balanced out volatility and being emotional about it.”
Goodsell added that it was, therefore, vital to make sure a client understands that volatility is not necessarily a bad thing, and that it can create opportunity as well as negativity.
With respondents saying they have 72% of their assets now allocated to active management, advisors are clearly favouring that strategy as they prepare to take advantage of opportunity. It’s something that contradicts the views of many investors.
Goodsell said: “What we know about investors from our past surveys is they see a cost advantage and they start to think it means greater benefits. This is an important part for advisors to talk about.
“Individuals think that index funds are less risky and protect them on the downside and that they give them the best opportunities, and we know all three of those things aren’t true. It can’t be less risky because it has no built-in risk management and it can’t protect you on the downside because they are designed to give you exactly what the market gives you.
“The final point is the idea that you don’t get the best opportunities in the market with an index, you get all the opportunities whether good or bad. But when you get an active manager looking at things, they are actually evaluating these potential investments and determining which ones fit best in a portfolio.”
Other findings from the survey include a big concern at the prospect of more volatility in addition to the following.
Threats to investment performance
Advisors see rising volatility as the biggest potential threat to the markets. Seventy-three percent say it would negatively affect overall investment performance; trailing as perils are asset bubbles (63%), geopolitical events (57%) unwinding of quantitative easing (57%), interest rate increases (56%), the low yield environment (55%), regulation (43%) and currency fluctuations (41%).
Impact of short-term rate increase
Advisors say an increase in central bank short-term interest rates is expected to adversely affect the housing market (75%), credit market (71%), bond volatility (68%), overall market volatility (65%) consumer spending (62%) and economic growth (53%).
Advisors’ top risk concerns are interest rate hikes (51%), asset price volatility spikes (45%), and low yields (38%). (Notably, advisors already are acting in response to the biggest perceived threat – rising rates – by managing bond durations.)
Concerns about bubbles
Advisors believe there are asset bubbles in the real estate market (49%), the tech sector (23%), the stock market (23%), and bond market (22%). They show the most concern for crypto-currencies. After those currencies experienced a considerable run up in 2017, 69% of respondents see them as a potential bubble that could burst in 2018.
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