The latest Spectrem Group survey of wealthy US investors has some interesting implications. Not least is the suggestion that ultra high net worth households in the US have quietly doubled their exposure to mutual funds in the past two years, at a time when much of the investment media has been obsessing over the rise of alternative investments and particularly hedge funds, and conventional wisdom has excoriated traditional collective investment managers for their perceived slothfulness and general incompetence and irrelevance.
‘Mutual funds’ of course are only a vehicle rather than a pointer to any specific asset class. Lest conventional fund managers feel prone to unwarranted celebration, America’s wealthiest investors have only raised their allocation to mutual funds from 6% to 12% of their portfolios.
The other allocations identified are as follows: managed accounts 23% (from 26% in 2003); individual stocks 18% (20%); deposits 13% (9%) – this also an interesting development given the headline unattractiveness of US cash rates; IRAs 10% (9%); individual bonds 8% (10%) – so just who is doing all the buying in the credit markets?; alternative investments, including hedge funds, private equity and venture capital 8% (9%) – which suggests that the latest hedge fund flows have been driven by ‘retail’ investors and institutions rather than the classically wealthy; other assets including commodities 6% (8%); and stock options and restricted stock 2% (3%).
Just from the headline percentages, what is also clear from the survey is that America’s ultra-rich households are remarkably disciplined asset class diversifiers. This would tend to support the conclusion originally reached by Daniel Bernoulli several centuries ago and which we invariably draw from, namely that rich people tend to focus on capital preservation before capital growth, on the basis that losses generate ill will more profoundly than gains generate pleasure. (This may go for ‘retail’ investors too, but the way the fund management industry tends to market to them suggests they are susceptible to pitches designed to appeal to those simply in search of a fast buck.)
Inasmuch as the Spectrem survey points to a general tendency towards risk aversion on the part of the rich, it chimes with the thesis advocated by Daniel Ben-Ami in ‘Cowardly Capitalism – the myth of the global financial casino’. Ben-Ami essentially argues – well – that far from comprising aggressive and uncontrolled speculation, the modern capital markets are characterised by an increasingly disturbing trend towards risk aversion and an almost pathological determination to avoid volatility at all costs.
In the context solely of investment risk, the Spectrem Group survey suggests that America’s super-rich show every sign of managing their portfolios in a prudent and diversified manner likely to preserve and enhance their wealth. But not every investor or investment institution is obliged to behave in similar fashion.
In what is surely one of the most grotesque developments within capital markets, conventional fund managers have succeeded in foisting the poisonous concepts of index benchmarking and peer group-relative performance upon their increasingly poorly served clients (the recent hiking of management fees by what are effectively institutional beta managers is just the latest example).
It is therefore wholly appropriate that absolute return managers are in the ascendant. Ironically, as more capital pursues absolute return strategies, there is evidence that the returns achievable from what one might call market neutral investing are falling, and in some cases falling hard. But markets are cyclical and recent trends do not invalidate the aim of absolute return investment. Rather, they underline the fundamental significance of portfolio diversification and, crucially, of manager and security selection.
And nothing is more risky than insisting on avoiding prudent risks. Safety is found in experience, in learning to live with the risks all about us. The greatest risk is to seek a safe world, rather than a safer world. In micro-managing risk rather than opportunity, institutional investors are setting themselves up for some dramatic problems ahead. It is not, perhaps, much of a surprise, for example, that UK and European equity markets have generated such impressive returns this year. Many institutional investors are substantially underweight them.
Tim PricSenior Investment StrategisAnsbacher & Co Ltd