It's human nature to follow the pack whether people find safety in numbers or fear they'll miss an opportunity others are enjoying. For your clients as investors, however, joining the pack might do more harm than good. It could mean they're jumping in and out of the market at the wrong times, causing irreparable damage to their long-term returns. Or the pack might take them where they don't belong — into higher risk or "hot" products that don't match their investment goals.
Let the ship sail
As advisors, you know all too well how investors run toward the strongest performance and run from the weakest. They want to win. They don't want to lose. In reality, though, by the time most investors decide to dive into a fund or abandon a sinking ship, they're already in troubled waters. More often than not, pack-driven investing results in buying close to market peaks and selling at market troughs; it rarely leads to sustainable returns.
In fact, during the global financial crisis of October 2007 to February 2009, $208 billion flowed out of equity funds during the last 12 months of the downturn, and from March 2009 to December 2013, $161 billion flowed into equity funds during the last 12 months of the rebound. Those investors would likely have been better off in funds with longer views and high-quality portfolios designed for less volatility in choppy markets. Of course, many investors who stayed the course and continued making contributions throughout the downturn also had some good growth in their accounts due to the simple but powerful benefits of dollar-cost averaging.
Turn down the trends
For investors, trends can be tempting and tough to ignore. Whether it's the promise of better returns in exotic fixed-income strategies designed to combat a low interest rate environment, or a new "uncorrelated" asset class for those who think equities have run their course, products like liquid alternatives and unconstrained bond funds are entering the market in waves. But these products can be complicated — and expensive. As evidence, the average expense ratio for alternatives is 1.71%, compared to 0.74% for equity funds. For an unconstrained bond fund, the average expense ratio is 1.15%, compared to 0.81% for core bond funds.
Are these costs justifiable? Do these products truly align with your clients' long-term goals, or is the appeal performance-driven? As an advisor, are you confident that the investment managers have the relevant expertise — in derivatives, for example, given that many liquid alternatives use leverage to boost returns? Just because investment managers can bring new products to market, doesn't necessarily mean they should. The best companies in this business will only bring to market products where they see promise in the long-term value proposition of an asset class and where they have the requisite expertise and resources in place to deliver on that promise.
More importantly, there are always opportunities in traditional equity and fixed income if you've got a skilled active management team to find them. I’d suggest this is as true now as ever, especially as we continue to see more market volatility. That's when active management provides the greatest opportunity to differentiate returns. That's when good research pays off. And that's when focusing on solid fundamentals, which truly drive value and sticking with your convictions, regardless of short-term momentum, provide the most meaningful opportunities for clients.
To get your clients to leave the pack mentality behind, take a page from the playbook of active managers. They purposely turn away from the pack — in this case their benchmark — avoiding full market risk and choosing the risks they take intentionally. Think of it this way: If everyone is fishing in the same pond, they're all swayed by the same tide and they're after the same catch. So it stands to reason, if you fish somewhere else and know where to look, you can reel in opportunities that others are missing.
James Jessee is Co-head of Global Distribution at MFS Investment Management. His comments, opinions and analyses are for informational purposes only and should not be considered investment advice or a recommendation to invest in any security or to adopt any investment strategy. Comments, opinions and analyses are rendered as of the date given and may change without notice due to market conditions and other factors. This material is not intended as a complete analysis of every material fact regarding any market, industry, investment or strategy.