WHY DID DEFENSIVE FUNDS LOSE SO MUCH OVER THE LAST YEAR?
Contrary to the name, defensive funds have lost -15% to -40% over the last 2 years. But why?
We all know the drill.
You want to invest but you have little to no knowledge or experience. You go to your bank or wealth management company, and they present you with the ‘goldilocks’ selection of funds – defensive, balanced and growth (with maybe a couple like ‘ESG’ and ‘Sustainable’ in between).
To the bottom left of the chart reads ‘Defensive’, and it’s nicely nestled at the lowest point between risk and return.
You know you’re not going to get high returns, but you’re also not putting your money at risk. Or are you?
The Problem with Model Portfolios
Model portfolios are predominately based on Modern Portfolio Theory; pioneered by American economist Harry Markowitz in his paper "Portfolio Selection" published in the Journal of Finance in 1952. He was later awarded a Nobel Prize for his work on modern portfolio theory.
The chief tenet of modern portfolio theory is diversification. Assets are classed as either high risk/high return or low risk/low return. The theory suggests that investors can get the best returns by choosing an optimal mix of risk and return based on the assessment of an individual’s tolerance to risk.
Whilst diversification remains crucial, the sustainability of MPT investments is now in question.
Over the last 2 years, as the developed world transitioned from negative interest rates and low inflation to high rates and high inflation, the ‘safest’ model portfolios – often named ‘defensive’ or ‘conservative’ – have lost between -15 to -40%.
Put simply, there has never in history been a time where we have had a globally coordinated lockdown of production, and globally coordinated increase in money supply.
The result of less production and increased money supply, with a high velocity of money (money going direct to citizens, not via banks)? High inflation.
The effect of high inflation on low risk, fixed income investments like cash and government bonds? Absolutely disastrous.
The banks and retailers of model portfolios, however, are in a position to do something – namely inform and warn clients of the changing investment landscape.
To this best of this author’s knowledge and research, to date nothing has been by institutions to educate and warn their clients in defensive or cautious model portfolios about the extreme erosion of wealth they are expected to face.
This includes those now going into retirement who are moving their life savings from their pension into ‘safe’ strategies in the hope of securing their retirement income.
Compounding this problem is the unwillingness of financial institutions to make broad changes due to the costs of portfolio restructuring, relabelling and education of their client base.
But why? The same institutions have been quick enough to rebrand their leading funds with labels like ‘sustainable’ and ‘ESG’.
Moreover, evidence suggests that a conflict of interest exists between investors and institutions who provide model portfolios that include their own funds. Wealth management institutions tend to include their own funds, gathering additional fees – even if competitor funds have better performance and lower costs.
The Rise of Apps and Self-Selected Strategies
The problem has been exacerbated by the rise of self-selected investment strategies.
Be it through online investment accounts or 3rd pillar pensions, financial institutions have cottoned on to the fact that pre-packaged is easier to sell, and have taken advantage of this by creating easy to use Apps with simple questionnaires that give investors a model portfolio aligned with their purported risk profile. This is a fool’s game.
Without taking into context your unique life and circumstances, how can a one-size-fits-all strategy possibly reflect the massive variation between people of the same age, gender, and income level. What’s more, how can such anachronistic portfolios account for unusual influences borne onto the market, brought about by central bank and government action? The short answer is they can’t.
What To Do About It?
If you want an investment strategy that truly reflects your risk profile, the context of your unique goals, and your desire to focus on ESG investment, then you need an investment professional to help you build a tailored portfolio.
At Imperial Wealth Planning, we don’t do model portfolios.
There’s no one size fits all, off the shelf solutions.
We are qualified and regulated independent advisors, specialising in providing bespoke, tailored solutions to fit the individual needs of our most valued investment - you.
Often, the concern is that you will need to pay a little extra for an expert’s time and knowledge. Expert support is of course not free, but we are transparent, fair, and like Warren Buffett said, ‘price is what you pay, value is what you get’.
Contact Us today for a free initial consultation.
Disclosure: This article has not been written to give advice, and purely expresses our own opinions. We are not receiving any compensation for it, and we are not responsible or liable in our capacity as an independent financial adviser for any action taken by readers based on these opinions. For personalised advice based on these issues, please seek advice from a regulated, independent expert.