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Specific allocation to NZ assets idiotic: Cleary

Financial planner Grant Cleary says it is idiotic that advisers make specific asset allocations to shares and bonds.

Wednesday, June 8th 2011, 10:50PM 16 Comments

Cleary told the Perfecting Investment Portfolios conference in Auckland yesterday that it makes "no sense at all" to have specific allocations in portfolios.

Rather allocations to asset classes should be "New Zealand economy neutral".

He said there was no mathematical basis for making such allocations.

Cleary said he wasn't saying don't invest in New Zealand, rather his view was that investments should be made on the basis of the best investments possible.

Clearly told the conference he likes allocations to commodities and "patronage infrastructure".

He was keen on Auckland Airport as it was such a good infrastructure investment. Likewise investments in the diary sector made sense because of New Zealand's strong presence in this market internationally.

His view on commodities was supported by keynote speaker Jonathan Pain.

Pain highlighted New Zealand as one of the emerging economies worth investing in because of its exposure to China.

Morningstar co-head of research Chris Douglas described Cleary's view as "a big call".

He said all markets have home bias and for New Zealand investors there are good reasons for investing locally. One of those reases was to get the benefits of the imputation credits tax regime.

Also there is benefit in having familiarity with the stocks people invest in.

Douglas also said that the idea of buying the best stocks globally could be difficult for individual investors and advisers to do.

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Comments from our readers

On 9 June 2011 at 1:06 pm blackjaguar said:
Unbelievable. The expression "no sense at all" is staying with me after having read the article, but not in relation to asset allocation.

One of the principal aspirations behind the new regulatory regime for financial services and financial advice, namely that financial planners will be encouraged to lift their game, seems as optimistic as ever.
On 9 June 2011 at 6:02 pm Independent Observer said:
I was fortunate enough to attend the conference where these comments were made and note the context in which Grant's comments were made. This was in response to a central theme in which discussion flirted around traditional portfolio construction (such as MPT) versus other methods.

Grant's comments attempted to highlight the flaws of myopic thinking by introducing an absolute return approach to portfolio construction. Importantly he noted the investor's (remember them?) attitude towards loss compared to their expectation of intermediaries outperforming cash.

The financial services industry is long overdue for these sorts of discussions, with the victims of the current portfolio-construction-mediocrity being the investors.
On 9 June 2011 at 7:31 pm Fortunate said:
I agree IO. Everyone should be looking to use strategies like absolute return funds. I think MPT is dead and buried.
On 10 June 2011 at 10:03 am Craig Simpson (Dentice Simpson Consulting Ltd) said:
I agree with the views of Independent Observer. I too attended this conference and was encouraged to hear people willing to challenge the merits of modern portfolio theory.

Historically I would have been called a traditionalist when it comes to Asset Allocation modelling. I still run M-V Optimisation as part of what I do not place too much emphasis on this.

There is a growing amount of literature on alternative ways to construct portfolios and this deserves peoples' time.

Mr Cleary also made a very important point on Monte Carlo simulations in that they are fundamentally flawed. Having done past research in this area I agree that Monte Carlo simulation is less than perfect. Research indicates that it is unlikely that the simulation will record consecutive periods where a negative return will occur and it ignores secular trends as well as correlations between market events.

Finally, another thing that stuck with me was that the only benchmark is CASH. When a client comes to an adviser they are comparing the performance of their portfolio against what they can achieve in a relatively risk free bank deposit.
On 10 June 2011 at 1:44 pm Fortunate said:
Yip - I haven't trusted my optimiser ever since it told me to buy a whole lot of finance companies companies and CDO funds.

Having lost faith in MPT, From here on in I am putting my trust in absolute return strategies. Show me a fund benchmarked to anything other than cash, and I will show you a disaster waiting to happen.
On 10 June 2011 at 1:59 pm Harry M said:
Portfolio De-Optimisation - How brilliant..........

We should call it the "Simpson Paradigm".
On 10 June 2011 at 6:44 pm blanketyblank said:
Fortunate, how could an optimser tell you to buy finance companies? Did you put that in as a specific asset class - (and if so, how did you determine the volatility given they aren't priced to market each day like shares and bonds?) or are you meaning the optimiser told you to buy fixed interest?
On 10 June 2011 at 11:54 pm Forthright said:
Reading these comments I wonder how many Advisers have researched the quantitative results for absolute return fund performance of funds available to NZ investors for the three years ending 31/3/11. There are not many ARFs which have outperformed the ANZ NZ 90 Day Bank Bill Gross Return Index after fees for the 3 years ending 31/3/11.
On 13 June 2011 at 3:07 pm Independent Observer said:
Forthright's response reinforces the reason for robust research screening in NZ... as there are a number of absolute return funds that have consistently outperformed the cash rate (or it's equivilant)
On 14 June 2011 at 8:37 pm Fortunate said:
Yip - I agree. The best investment funds that you can have are ones that invest actively in stuff like shares - but benchmarked against cash. You then want to make sure that there is a performance fee like 10% or 20% of the outperformance versus the cash rate.

Funds like this are the way to go.
On 15 June 2011 at 10:36 am Kimble said:
So the market does 10%, cash does 5%, and you pay an extra 1% in fees on top of the 1%+ ordinary management fee, thanks to the manager investing in an ETF and a 20% performance load? Bargain.
On 15 June 2011 at 6:59 pm Independent Observer said:
Kimble - it may be worth your while (and your clients) for you to take a closer look at absolute return funds. You will discover a couple of things:

1. There is a lot of crap available (but then - there is a lot of crap available in the financial services industry full stop)

2. The quality absolute managers consistently outperform most traditional and cash metrics - through active management & an ability to go to cash / short if required.

3. Most of the returns achieved by quality absolute return managers are net of fees & expenses and still manage to consistently outperform traditional investment buckets that use meaningless benchmarks.

Unfortunately the myth of gaining a cost-effective exposure to markets/segments through a passive investment such as an ETF is little more than a clever marketing ploy espoused by the beneficiaries of such information. Ultimately your clients get what they pay for.

But then – don’t believe me. Do your own research and you’ll soon discover the myths versus realities
On 17 June 2011 at 1:52 am Kimble said:
First of all, ETFs ARE cost effective exposure to the market, thats not a myth or simply marketing. They give you a very diversified portfolio relatively cheaply. If extreme diversification isnt market exposure, then what is? If ETFs arent the cheapest way of getting this exposure, then what is?

What it looks like you are arguing is that people should not have exposure to the market. But thats not the same thing.

I was talking about what Fortunate said, paying a manager (who only invested your money in an ETF, meaning he didnt really do anything) a performance fee only because you set his benchmark to cash.

Fortunate is giving the manager credit for outperforming a riskless asset by any amount, regardless of whether it was the result of his skill. He is, in effect, giving the manager a bonus on top of the management fee, simply for investing in risky assets. At the very least you should TRY to pay him based on his contribution to your return.

Note that I wasnt advocating only investing in ETFs, nor was I saying that absolute return funds are necessarily bad or that they always lose money. In fact, you still dont know my opinion on either of those things.
On 20 June 2011 at 6:01 pm Craig Simpson (Dentice Simpson Consulting Ltd) said:

ETF's while being "cheap" viz a viz an active manager, in a large number of cases simply replicate the market using synthethic instruments and not by holding physical securities. The replication is not a complete one either. A large number of ETF's have a replication rate of around 85%.

Also late last year the SEC lablelled ETF's derivatives so I hope your mandate to manage client money permits the use of derivatives.

Russell put out a paper on the Gen IV ETF's some time back which is worth reading. I took one look at the structure and thought they were looking very over engineered and had moved away from their original purpose.

You should also try and get your hands on a presentation Alan Goldman (Analyst for Goldman Henry) put out for the Fundsource Conference this was an excellent piece of work and certainly opened a few eyes as to the pitfalls of using ETF's.

On 21 June 2011 at 12:31 am Kimble said:
And another comment on ETFs but no response to performance fee point.

My point was never that ETFs are great. I simply used them in an example to show how a cash benchmark may not be the best. So far nobody has addressed that.

SPY does 20%, your US equity manager does 10%, and because cash does 5% you pay him an extra 1%.
On 22 June 2011 at 9:54 am PC Heretic said:
I agree with Kimble. A cash benchmark is as much of a marketing ploy as calling your fund Absolute Return. As 2008 showed many AR managers have been effectively getting paid for beta (or exotic beta) in addition to alpha. I have no problem paying for something but not if I can get it 1/4 of the price next door.

While clients may compare portfolio returns to a cash rate, 99% of the time it is irrelevant. What is important is the rate of return which will allow them to achieve their own objectives - that is the only relevant measure.
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