It is popular at the moment for market participants to say “Investors’ risk appetite is increasing”. They mean that as share markets rise, so more investors lose their fears and decide to buy. Quantitative easing is providing more money for asset purchase. The feeling that the worst of the banking crisis is behind us assists. Every figure suggesting that the worst of the economic decline is over helps build the bullish story.
Investment funds for the retail market are graded according to how much risk they are running. Risk is usually measured by looking at past price changes for the assets the fund is invested in. Share prices go up and down a lot, so they are perceived as risky. Bond prices go up and down less so they are a bit less risky, whilst deposits in strong banks hold their value whatever happens.
The problem with grading funds by risk and telling them to keep to those characteristics is that people’s feelings about risk change over time. If a client came with new money in March 2009, after a long period of collapse and decline, he or she might feel have felt they wanted to be very cautious. That turned out to be the time when you should have wanted maximum risk if you wanted to make money, as the risky assets were very cheap and about to rise substantially. A good adviser would have said, why not take some risk? A month or so later the investor might have seen that things were improving, and wanted to own more shares. If he had invested in a graded low risk fund that would require switching from one fund to another.
Asset allocation advice for funds is based on this essential perception, that you might want to alter now much risk you run over time. It might be sensible – as we thought – to run very little risk in a year like 2008. A prolonged Credit Crunch was all too likely. We had seen the financial disasters in 2007 and thought there were many more to come. In 2009 it seemed a good idea to run more risk. Returns on cash had plummeted, and riskier assets had fallen a long way to discount the dangers.
That’s why, for discretionary larger clients we have shifted portfolios from all cash to fairly fully invested, and why as markets rise we are taking some profits. For smaller investors we now offer investment advice to IFAs, so you can use our service through an IFA who has signed up. Today we are recommending a balanced approach, with a mixture of bonds and shares, as we have seen good rises in share markets. We think there are problems ahead for the large debtor economies which the markets have chosen to ignore for the time being.