‘Find your inner truffle hog!’ was the rallying call of Dr Bert Flossbach, CEO of German asset manager Flossbach von Storch, during an entertaining and eye-opening presentation at the FONDS professionell conference in Mannheim in late January. He wasn’t addressing an audience of exotic-fungus hunters in need of some spiritual guidance, but rather a roomful of predominantly German fund selectors and other industry professionals keen to glean some advice on how to best serve their clients in the current investment climate.
What really stuck in my mind from this session were several slides about the mismatch between what conservative investors want and what they can feasibly achieve. Dr Flossbach highlighted hypothetical examples of Swiss and German investors looking to park a chunk of cash somewhere where it will preserve its value. A sensible-sounding target return of 2% (after tax and fees) was put forward, just above the ECB’s own target inflation rate.
Alas, in this world of ultra-low or negative rates, 2% isn’t quite the easy win that it once was. In instant-access cash deposits, forget it. As for bonds, at the time of writing in mid-March, AAA-rated Eurozone government debt yields are currently negative almost all the way out to seven-year maturities which, given the ECB has just cut rates again, is already nearly a year longer than was the case in late January when the presentation was delivered. The equivalent yield curve for Swiss government debt is negative over an even longer time horizon.
The reason that Flossbach’s session was eye opening was what he told us next. That 2% return is much more achievable in a mixed assets fund but with the crucial caveat of a significant degree of risk; by his calculations, the fund would need an equity exposure of around 50% (a little more for the Swiss, less for the Germans), based on the average fund performance in the mixed arena. Now, Flossbach von Storch clearly has a vested interest in highlighting the beauty of mixed assets, given the firm’s strength and popularity in this arena but it is right to point out this entrenched difficulty faced by investors and the asset-management industry alike.
But do investors recognise and/or accept that they need to shift their mindsets? It is after all something of a paradox to essentially say that, in order to stay safe, you must take risks. There has long been a psychological barrier to risk among many European investors, with bonds seen as the only answer. With regards to funds, this is reflected in the important role that bonds play in the asset mix of all major European markets; in the cases of Italy, Spain, and Austria, it is their domestic industries’ largest asset class. But there has been strong evidence of a shift into mixed asset funds over the past three years, which suggests that some investors have been willing to trade in some risk aversion.
This in itself raises another question: do investors fully understand what they’re investing in? Anecdotally, we have heard of consumers equating the concept of ‘absolute return’ (which is a feature of many mixed asset products) with ‘guaranteed’, which is likely to have made for some unhappy investors in recent months, during which equity performance has been exceptionally bad. Indeed, recent research from Fitch Ratings found that positive performance was registered by just 11% of absolute return funds during the 12 months to the end of February. Will investors remain focused on the long term?
As ever, much of this boils back down to the perennial challenge that is investor education. We know from Fund Buyer Focus research that selectors have been more intent on making new allocations to equity and ‘other’ funds than other asset classes for much of the past year. They are evidently keen to persuade their clients of the benefits of such moves but many retail investors will prove resistant to such change and the market volatility of the past few months is likely to render them even more recalcitrant.
I’m not trying to suggest that bond funds should become a no-go zone for investors, nor that they should dive wholeheartedly into equities. Better yields can be achieved without departing the bond asset class although, here too, the acceptance of more risk is necessary. Either way, if investors want to unearth some more delights for their portfolios, then a little more risk-on diversification is arguably precisely what is needed. Just like truffles, equities aren’t to everyone’s taste – but more investors may have to learn to tolerate them.