As we enter a more volatile period in financial markets, investors and wealth managers alike will need to work harder to earn returns. The evidence I see suggests that many investors are far from ready.
Financial markets have been kind to investors in recent years. Supported by persistent growth in the United States, Europe's recovery from its political and monetary crises, and China's robust expansion, alongside massive support from central banks around the world, the global stock market (MSCI All-Country World Index) has delivered returns of more than 10.7% p.a. since the beginning of 2013.
And what has been kind to investors has been kind to the wealth management industry. Our potential client base has grown: the number of high net worth individuals globally has grown by 38% since the end of 2012, according to Capgemini. And assets under management have expanded: at UBS Global Wealth Management from around CHF 1.6 trillion to more than CHF 2.3 trillion between end 2012 and end of June 2018.
But we cannot reasonably expect such strong tailwinds to persist. The economic cycle is maturing, with unemployment now at cyclical lows in the US, Japan, and the UK. Central banks are unwinding extraordinary monetary policy support; by the end of this year they will, in aggregate, be withdrawing liquidity from the global economy for the first time in a decade. And protectionism, and various other geopolitical threats, pose a risk to global growth.
Concerns about a combination of these factors have already contributed to the return of volatility in 2018. We should prepare for this to continue, but many investors are not ready. A combination of our human inclination to favour the familiar, our short-term fears and occasional greed, and an underappreciation of personal circumstance, can leave unprepared investors hostages to fortune.
For private individuals and families, the consistent and disciplined implementation of three proven approaches are key to protecting and growing wealth, today and over generations – thinking globally, thinking long-term, and recognising individuality.
First, thinking globally. The theoretical and empirical underpinnings for this are clear. Looking at data since the beginning of 2009, global stocks have delivered comparable or better returns, with lower volatility, smaller drawdowns, and less significant daily drops than all other major markets, see table. Over that period, it would have taken an investor in Swiss, Chinese, or German markets over ten years to double their wealth vs. just over seven for a globally diversified investor with the same level of risk.
Source: Bloomberg, MSCI, UBS, as of October 2018
Yet many individuals still exhibit home bias. For instance, despite the potential loss of performance and higher risk, 54% of our Swiss clients who are active investors, still hold more than half of their assets in Swiss companies (UBS Global Wealth Management data). There is, in many cases, little reason for this beyond familiarity. Firms like my own need to make it easier for clients to invest portfolios globally, and work harder to show how this improves returns and reduces risk.
Second, thinking long-term. At a time of uncertainty over the economic cycle it can be tempting for investors to try and time the market. Yet with average returns in the final year of a bull market at 22%, and in the first year of a bull market at 40%, (UBS Global Wealth Management, Chief Investment Office research) getting out of the market and back in again at the right time is near impossible. Regularly rebalancing in a disciplined manner toward a target strategic asset allocation is likely to prove more effective than market timing for most private investors. And short-termism doesn't just bring with it the cost of mistiming. Private investors have unique advantages over institutional investors, such as the ability to hold illiquid assets in exchange for extra return, but these are forgone if investors trade in and out.
Our analysis shows that mutual fund investors' buy-and-sell decisions imply average annual underperformance of 0.9% per annum, relative to those investors that stayed invested, over the past decade. We also see that self-directed – or do it yourself – investors find it hard to make impartial, emotionless decisions. Over the past five years, when comparing portfolios of similar risk in our Swiss booking centre, just 14% of our clients with self-directed portfolios materially outperformed those who delegated responsibility for their portfolios while 51% materially underperformed. In the long run, those investors who overtrade, and those wealth managers that encourage portfolio churn simply to generate fees, will underperform those that take a more strategic, longer-term approach.
Third, recognising individuality. No two clients are the same. Individuals and families have different attitudes to risk, different ambitions, different constraints, different values, and different personal situations. These each need to be deeply understood, and be accounted for in portfolios. And this isn’t just about meeting regulatory requirements, or satisfying wishes. It is an integral part of effective wealth management. Investors who are comfortable with the behaviour and composition of their portfolio, and who can see how their portfolio aligns with their personal goals and values, are more likely to retain the necessary patience to earn long-term returns, and less likely to panic sell during periods of higher volatility, crystallising losses or forgoing potential gains.
Advisors and investors that fully understand the unique circumstances surrounding every investment decision are, ultimately, in a far better position to provide advice and make decisions that are truly in the best interests of the client. This is particularly important in a time of market volatility when short-termism and emotions risk dominating decision making.
It is clear to me that the road ahead will look quite different from the road behind. But I do not believe that values and disciplines needed to protect and grow wealth today and over generations have changed. Thinking and investing globally, taking a long-term view, and accounting for individual goals and needs remain the keys to success, both for investors, and for the wealth managers that support them.
Martin Blessing is Co-President of UBS Global Wealth Management