IFA of the year 2010: Steady pace suits a long-haul race

Published on Wednesday 1 September 2010 14:24

In the midst of the investment marathon, switching strategy in pursuit of a quick buck usually backfires, writes Raymond Ellis

Each of our IFA of the Year hopefuls started the competition in mid-February with 300,000 to invest on behalf of our case-study couple, Chris and Fiona Anderson. Six months down the line, their investment portfolios have been exposed to a great deal of volatility and all the uncertainty that surrounds a potential "double-dip" recession or a raging bull market.

I am obliged to point out, as a judge, that the final result of the competition will not be determined entirely on investment performance. At the outset, our competitors were obliged to submit an investment report which will be used along with their portfolio management skills and their investment commentaries to determine the final outcome – fortunately we have until the 31 December to make that final decision.

Looking at investment performance in isolation, there is almost a 7 per cent difference between the best and worst portfolio performance – in monetary terms that's a whopping 21,000 – so what's made the difference? Well, yet again this competition is a good lesson in effective portfolio management and the key question for our competitors and all potential investors is "what poses the bigger threat to investment markets in the medium-term – deflation or inflation?" The answer will determine just how our IFAs approach their asset allocation calls. Assuming their clients are still comfortable with their "speculative" attitude to risk, should they stick with their original asset allocation, or are there some short-term tactical changes that could be made?

Most investment professionals still believe the mantra about investing for the long-term but, in recent times, the capricious nature of investment patterns from some investors shows this belief is beginning to be questioned. The reality is that few private investors act with the long term in mind, instead they frequently turn over their portfolio, buying high and selling low, because they seem to be obsessed with short-term performance.

These short-term performance chasers tend to be emotional and impulsive. When investment benefits are not seen immediately, they get frustrated and switch managers and/or investment strategies. The problem is that short-term performance chasing tends to lead to underperformance, due in part to the dealing costs that these regular changes incur.

This trend of switching funds at the "wrong" time explains why, over 20 years to December 2009, the average private investor has only achieved a return of 3.2 per cent per annum, barely beating inflation, whereas the UK equity market has risen by an average of 8.8 per cent per annum. It only goes to prove that short-term performance is due more to good luck than good judgement. Asset allocation is still the largest contributor to investment performance within a portfolio. This theory, known as Modern Portfolio Theory, holds true today as much as it did when Harry Markowitz published his original paper in the American Journal of Finance in 1952. He was subsequently awarded a Nobel prize for Economics.

• Raymond Ellis is director of Scott-Moncrieff Wealth Management