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Hedge Clippings | Friday, 29 October 2021
Risk Warnings - protecting the investor or the fund issuer?
Anyone who has ever invested in a managed fund should be well aware of the "Risks" section in the offer document, with probably the most well known one relating to past performance. With due respect to our legal friends, and if it comes to that, ASIC as the regulator, it strikes Hedge Clippings that the section on risk is more likely to be there to reduce the risk to the fund manager as much as, or possibly even more than, the investor.
There may be a number of reasons for this, but whether the investor actually reads the risk section (normally tucked well towards the back of the PDS or IM), or fully understands them doesn't make a lot of difference: On the application form - paper or via Olivia123's online application solution - the investor acknowledges they've both read and understood the risks.
Hedge Clippings is not suggesting that the fund managers or their legal advisers are doing anything wrong or underhand, and 99% of the time they're above board (the other 1% being outfits like Mayfair 101). ASIC's recently introduced TMD (Target Market Determination) regime has attempted to rectify this, but it remains prescriptive, and depending how it is implemented, it remains to be seen who it protects more - the product issuer, or the investor.
So Hedge Clippings thought we'd come up with our own series of risk warnings for investors - they might not be "advice" in the legal sense of the word, but these "Rules" might be helpful in avoiding some well known pitfalls.
Rule Number 1: Diversify!
Commonly known as "not putting all your eggs in one basket". Diversifying might reduce your returns in the good times, but diversifying across asset classes, strategies and managers reduces your risk when compared with investing in a single asset or managed fund.
Rule number 2: Correlation!
Diversification doesn't help if all the assets (or funds) you invest in are highly correlated - in a market shakeout or period of under-performance they're all likely to move in the same direction.
Rule Number 3: Ignore the hype! (also known as "fear of missing out" or FOMO)
Investing (as opposed to speculating, or punting) is for the long term. There may be a frenzy about this or that, but these come and go. Think tulips and "Tulip Mania", which occurred in Holland in the early 1600's. There have been bubbles since, and there will be in the future - and some will see Crypto as hype, although not all crypto funds are the same. Still suffering from FOMO? Invest, but refer to Rule Numbers 1 and 2, and then number 4.
Rule Number 4: Look before you leap!
Otherwise known as "doing your research" - we could bundle up a series of rules under this one. In the building industry there's an old saying "Measure twice. Cut once". At FundMonitors we refer to it as Compare, Research, and then Invest.
Rule Number 5: Words are words, but only performance is reality.
This also covers a range of warnings. How often have we heard the sad tales of poor investments - or total loss (Mayfair 101 again) based on the premise such as "I liked the manager" or "my friend recommended..."
Rule Number 6: Understand the Ratios!
There's a whole box full of ratios and formulas used in the research reports. Sharpe, Sortino, Up Capture, Down Capture, Drawdown, Alpha, Beta - and that's before we start on fees and high water marks. If you're going to do your own research, it's worth getting your mind around them.
Rule Number 7: Fees aren't always bad!
Now this becomes tricky. High fees and poor performance are bad. So by the way, are low fees and poor performance. Generally in life you tend to get what you pay for - a good glass of wine for instance, is normally better than a glass from a box of Chateaux Cardboard, even though they contain the same alcoholic content. So when evaluating fees, make sure you're getting what you pay for.
Rule Number 8: Understand your risk and reward tolerance - or "know thyself".
All investments involve risk. (That's straight out of the offer documents!). What's your tolerance for risk? To be fair that's part of what ASIC's new TMD regime mentioned above is all about.
Rule Number 9: Markets Fluctuate! So does manager and fund performance.
This could be Rule number 3 below Diversification and Correlation, but it's not quite so clear cut. As we've pointed out in the past, the Top 10 performing funds in the five years to 2015 is a different group to the Top 10 to 2020. While investing in managed funds is a long term exercise, it's not set and forget.
Rule Number 10: Take Professional Independent Advice!
We recently saw a statistic that only 15% of Australians use a financial advisor. There may be all sorts of reasons for that, including some of the evidence presented to the Hayne Royal Commission. If you understand the above rules, by all means do your own research. If not, you should probably seek expert advice. If you're going to use an advisor make sure they're independent and recommended. But that's probably opened up another set of rules for another edition of Hedge Clippings.
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