From time to time, we will get this question about the way we manage wealth for our clients: “why should clients pay you an ongoing advisory fee if you take a “passive” instead of an “active” approach to investing?”
In the investment world, an active investment strategy is one whereby the investment managers will switch from one asset class/country/region/theme to another or pick securities based on short-term market forecasts to try to get higher than market returns (also known as alpha). This is as opposed to passive investment managers who buy a basket of securities that simply tracks an index and do not make frequent changes due to short-term views of the markets. In doing so, they will only get market returns. Because of the term passive, it seems to suggest that it is an inferior, lazy approach where there is nothing much being done once an investor invests and because passive managers do not give excess returns over the markets, there is no value added and perhaps one should just DIY and avoid paying extra fees to wealth advisers like us. But to debate on which is the better approach without first determining the type of clients we are investing for and what problems we are trying to solve for them is like putting the cart before the horse and therefore futile.
For my firm, our clients are primarily family stewards whose dominant focus is to take care of their families and they are conservative in their personal and professional lives. When they come to us, they want us to help them reach their non-negotiable life events (such as retirement) without compromising their shorter-term life goals (such as taking a one-year sabbatical to pursue a worthwhile cause with a non-profit organisation). Therefore, they are not looking to maximise their investment returns but rather the reliability and sufficiency of the returns to meet their needs. To achieve that, the better approach would surely be based on evidence rather than trying to outguess the market.
I have written numerous articles on this column that while there are some active managers who can beat the markets, scores of evidence show that most do not and even for those who did, they cannot do it consistently. Therefore, the evidence-based way to get returns is via globally diversified portfolios using passive low-cost index and systematic investments and staying invested for the long term instead of making frequent short-term adjustments based on guesses no matter how smart they may seem. But for this “passive” approach to work, there are 3 areas that needs to be active.
Wealth Planning
In order to ensure that clients’ wealth plan can achieve their life events and goals with higher certainty. We need to work out the amount of funds and the suitable asset allocation that they should invest and stay invested in. Therefore, the future expected returns of the stock markets need to be properly estimated. One model that investment analysts use is the Ibbotson-Chen Earnings Model developed by Dr Peng Chen (who is currently my firm’s Senior Advisor) and Roger G. Ibbotson which was published on the Financial Analyst Journal in 2003 and adopted as a fundamental reading and testing for the Chartered Financial Analyst examination. The model breaks down the overall equity returns into various components and examined the historical data and scrutinized each component in forward looking setting to come up with the final estimate. While it is an estimate, because it is scientifically developed, there is a basis for us to make adjustments, when necessary, throughout the lifetime of our clients because the markets are always changing. This process can hardly be described as passive.
Investment Management
While we do not actively manage our portfolios in ways the industry defines it to be, it does not mean nothing is done on an ongoing basis behind the scenes. We hold quarterly meetings with the fund managers that we work with and actively checked the investment behaviours (these includes but are not limited to their returns and risks) of the portfolios to make sure that it is working the way it should be. In addition, we continue to scour for suitable instruments that we can use to improve the investment experience for clients even though we don’t always include every instrument we looked at. An example would be that we incorporated ETFs that tracked China Government Bonds but did not add Treasury Inflation Protection Securities (even though we did a study on it) in the recent changes made to some of our portfolios. The portfolios are also actively being rebalanced on a regular basis or whenever needed so that it continues to reflect its correct asset allocation. I do not think anyone can say we are passive in this area. Learn how we add value to our clients through active investing, the Providend way, here in this article.
Investor Psychology
While we know from evidence that staying invested for the long term is the most reliable way to get sufficient returns, we know that in the short run, there will be plenty of noise which will cause volatilities and in turn can cause investors to feel uncomfortable and sell out prematurely. If they do so, they will then not be able to capture the returns they need and possibly even lose capital. As such, besides doing proper cashflow planning before and in retirement for clients that is customised to their individual circumstances, we actively execute a turbulence management plan that includes investor education from the time clients are onboarded and throughout their lifetime and also a series of communication and handholding activities through market volatilities. As a result of our “active management”, we hardly had clients who panic sold in 2022 when markets were uncertain but instead added more money into their investments. This allowed them to capture the returns when markets started recovering since the beginning of 2023.
So, whenever I am asked on whether we use the active or passive approach to investing, my answer is that we are evidence-based. We are passive in areas where evidence show us that it is better to be passive and active in areas where we cannot afford to be passive. This philosophy is born out of our experiences managing money through many crises. We know what works and won’t work. While this approach may not suit every investor, from our experience, it is best suited for those who aren’t looking to maximise their returns but looking for a more reliable way to get sufficient returns to achieve their non-negotiable life events and goals. As an individual investor, you need to decide what type you are and the best approach that suits you.
Below is also a short video where we detail what we do for the fees we charge, in comparison to the robo-advisors and DIY investors who invests with an online brokerage.
The writer, Christopher Tan, is Chief Executive Officer of Providend, Singapore’s first fee-only wealth advisory firm and author of the book “Money Wisdom: Simple Truths for Financial Wellness“.
The edited version of this article has been published in The Business Times on 17th July 2023.
For more related resources, check out:
1. Active vs Passive vs Evidence-Based Investing
2. How Can I Invest Confidently?
3. Generating Superior Returns vs Just Enough : Focusing on Your Goals When You Invest
*Providend is very excited to share that we are now ready to extend our service offerings to the younger accumulators who are looking for holistic, independent, conflict-free wealth advice!
For this group of younger accumulators, we know that it is not easy to make retirement planning a priority when other financial goals – buying a first home, for example, or saving for a child’s education – appear more pressing. Learn how we can help here.
We do not charge a fee at the first consultation meeting. If you would like an honest second opinion on your current estate plan, investment portfolio, financial and/or retirement plan, make an appointment with us today.
