Showing posts with label investment management. Show all posts

Is transparency enough?

Last night's Panorama investigation into pension fund charges, and this article in the Telegraph, have once again shone the spotlight on fund charges. The conventional wisdom seems to be to push for greater transparency in fees. I'm all for that - but I am not sure it will be enough.

Knowing what fees you're being charged is one thing. But I don't believe that the average investor is able to fully understand the impact those fees have on their pensions and investments. It takes a fair amount of sophisticated maths to calculate the fee drag on £100 a month invested with a 1.25% management charge, not too mention any other charges such as dealing and custody charges that may be thrown in on top.

I believe a better solution would be to force all funds to report performance after all costs have been taken into account. The equivalent of an APR calculation for fund performance, if you like. That way, investors would be better able to assess whether their pension fund had performed better than their cash in the bank over the last year.

(Where a fund changes its charging structure, the rules could be such that the fund would also have to restate its historic performance as if the new structure had been put in place.)

Of course, that provides a backward looking view only. So we'd still need all the transparency in order to formulate a forward looking view. However, I believe it would put the average retail investor in a much better position to assess whether they felt they were getting value for money.

What do you think?

Project management lessons from investment management

In ROI: Risk of Ignoring, I started to explore investment management as a metaphor for strategic project management. Here are some more lessons from investment management:

Risk / Reward: it follows, I think, that the projects with the greatest potential risk for failure carry the greatest potential rewards (all other things being equal). In traditional finance theory, advisors establish the risk tolerance of a client. Organisations too have a project risk tolerance. Conservative companies are just not that good a high risk projects - which goes a long way to explaining the relatively low levels of innovation (historically) in the financial services sector compared to the dot com sector, as well as the re-invention of big pharma.

Diversification: particularly at the higher risk end of the spectrum diversification pays - that is running a portfolio of projects whose failure points are not correlated dramatically increases the chances of success. In organisational terms, that means not focussing all of your innovation and investment in one division or area of the business at the expense of the rest. It also warns those business who pin their hopes on a single transformative initiative. (On the other hand, people can only deal with so much change at a time, so that needs to be managed too.)

Profit Taking: with investments, it makes sense to sell investments once you've made a respectable profit, rather than hanging on for the investment to peak, thereby leaving something on the table for the next investor. Similarly, it make sense to get you products out there before they have every last feature implemented. It's better to get something out there than it is to wait until the market turns and someone else has mopped up your target market.

Liquidity: investments that are easy to monetise are more attractive than those that are not. Look for project structures that are easy to disaggregate into pieces that are easily repurposed or multi-purposed. Look for early wins that impact the bottom line. This is why Agile methods have become so popular.

Risk profiling and asset allocation - is there a better alternative

One of the things I've been worrying about lately is whether or not there are any viable alternatives to the traditional approach of risk profiling and asset allocation.

There are, of course, a number of well documented shortcoming with the existing approach (see, for example, McCrae's research: Profiling the Risk Attitudes of Clients by Financial Advisors: The Effects of Framing on Response Validity. I am assuming that we're talking about a robust approach to risk profiling and asset allocation, based on a reasonably accurate "attitude to risk" profiler, incorporating goal specific information and timelines (capacity for risk), thorough analysis of efficient frontiers, and regularly reviewed and adjusted. (Any approach that ignores those factors is bad, without detracting from the underlying principle.)

The main criticism that I encounter is that risk profiling questionnaires are inaccurate. That is obviously true. What you really want to now is what is the customers optimum trade off between risk and return. But given that most customers don't understand return (many don't even understand percentages) or risk (even fewer understand probability, let alone probability distributions), it follows that you have to settle for the closest approximation of this that you can find - which will always be slightly inaccurate.

A number of improved approaches have been suggested, for example:

However, these all seem to be based on finding an improved way of presenting risk profiling and portfolio selection processes to the customer, and don't represent alternatives to the basic underlying concepts.

So it seems to, that despite its failings, there is no real alternative to risk profiling and asset allocation, and the best we can do is to strive to improve our tools for performing the existing process.