How the nature of investment needs to change
04 October 2019 | Robyn Laidlaw
The coming generation of clients face significant challenges, but advisers can offer solutions.
The savings industry has never been more important to our success as a society, and has rarely faced a time of so much disruption.
A new cohort of clients is coming of age, the generation often known as millennials. The first of them reach 40 in 2020 and, over the next five to ten years, they are likely to start looking for financial advice.
The life experience that they bring with them, not least in respect of finance, will be very different from that of their parents. Their life expenses will typically have been significantly more burdensome than those of their parents and grandparents. Few will have the security of defined benefit pensions, yet they face the prospect of supporting themselves through much longer lives, with all the risk that that entails.
Financial markets, according to Vanguard's investment strategy group, are unlikely to provide an easy answer. In the 30 years preceding the global financial crisis, average annual returns for a 50/50 equity/bond portfolio were 11%1. These strong returns were driven by a number of one-off factors such as post-1970s disinflation, the opening of global markets and the adoption of new technology.
Since the global financial crisis, a new set of factors has come into play, low-to-negative interest rates and quantitative easing. These emergency measures helped push up returns on both bonds and equities, in both developed and emerging markets. As they are wound back, we expect to see the opposite effect, with investment returns coming down to relatively low levels.
There is broad recognition of the risk that coming generations may be less financially secure than those that preceded them. Careers are more fragmented and benefits are less secure. The response has been – and is likely to continue to be – still closer regulation and more intense official scrutiny of the entire value chain from advice through platforms to asset management.
MiFID II has not been two years into its implementation phase, and processes around the product governance requirements are still forming, yet the Financial Conduct Authority has already announced that it is ready to revisit the Retail Distribution Review and the Financial Advice Market Review.
What needs to be done? In our view, two things, and advisers play a key role in both.
One is that investment behaviours need to change. This is not just a matter of stepping in when the going gets tough but about setting good goals and making a clear plan to serve as a benchmark against which to guide activity2. Vanguard's empirical research into the value of advice shows that emotional wellbeing is an important component3.
Another component, also behavioural, involves guiding clients to understand and accept appropriate levels of risk. Advised clients, according to Vanguard's research, tend to have more balance in their portfolios, with changes typically involving a decrease in cash and an increase in international holdings, both equity and fixed income3.
The second change is in investment strategies. Longevity means much longer investment horizons, such that a client coming for advice at 45 will now on average need to be invested in some form or other for at least 40 years. A couple in the upper income bands, if both are 45, are likely to need to be invested for at least another 50 years4.
Investing over such long horizons, through a period of increasing client needs and muted returns, multiplies the importance of minimising costs. It further means making the right active/passive choices, avoiding over-reliance on individual or ‘star' managers and avoiding unintended concentrations around such factors as style, sectors, regions or capitalisation.
As millennials come to seek financial advice, they face significant challenges, but there is an opportunity for advisers to offer solutions drawing from both professional experience and empirical research. It is widely accepted that the demand for financial advice far exceeds supply, and given the current outlook, it is little wonder.
Hear from Robyn and learn more on this topic at our upcoming Vanguard Investment Symposium on the 15th and 17th October in Harrogate and London.
1 Source: Vanguard calculations from Thomson Reuters Datastream; global equity comprised of 25% UK equity and 75% global ex-UK equity, where UK equity is represented by MSCI UK and global ex-UK equity is represented by MSCI World ex UK from 1978 to 1987; MSCI AC World ex UK from 1988 onward. Global bonds are comprised of 35% UK bonds and 65% global ex-UK bonds, where UK bonds are represented by FTSE UK Government Index from 1978 to 1999, and Barclays Sterling Aggregate Index thereafter and global ex-UK bonds are represented by Barclays US Aggregate Bond Index from 1978 to 1990, Barclays Global Aggregate Index from 1990 to 2001; Barclays Global Aggregate ex GBP Index from 2001 onward. Data is to end-2007.
2 Advisor's Alpha guide to proactive behavioural coaching, Vanguard 2018
3 Assessing the value of advice, Vanguard 2019
4 Based on Office for National Statistics 2016 life expectancy data