by Denis Carroll*
Group consensus is an amazing thing. How many times in the recent past, up until COVID-19 hit, have we heard expert commentators and fund managers tell us everything was looking good for a global recovery? Prior to the pandemic, the US continued to look strong going forward, Europe was making moderate gains and China would do whatever it had to in order to continue its growth trajectory, the consensus said.
Most pundits seemed in general agreement, save for the usual small pocket of habitual naysayers. And then – shock, horror – the insidious corona virus struck, and the world has been turned on its head with massive human loss alongside economic loss upon us or looming. There will be, the new consensus tells us, a global recession.
And then we have market losses. So far, this has meant the biggest daily falls for 29 years, followed by the biggest weekly rise for 46 years (both for the S&P 500, with the Australian market pretty much in lockstep). Unfortunately, that biggest weekly rise, just the week before last, has not yet made up for all those daily falls.
And thrown into the mix of risks is political risk. For instance, the response by both Federal and State governments in Australia gathered pace before many other countries, to the credit of our governments. But some of the measures would be judged doubtful in a more considered environment, such as the decision to allow unemployed or other benefits-eligible people or those whose income has fallen 20 per cent or more to withdraw up to $20,000 from their super accounts without question. Adding to the result of political risk we have seen certain politicians, who have been long-time opponents of not-for-profit super funds, seize the opportunity to question their liquidity in the event of sudden drawdowns. As of April 8, according to the ATO, 618,000 had expressed interest in drawing down at least the first half of the $20,000 allowable.
So, has this been some sort of plot or has it just morphed over time into the current scenario? Aside from the virus itself, what is also scary is the relevant self-assurance of our financial “experts” who didn’t see any of this coming, or more importantly had no idea what to do when it did.
Certainly, nobody could be blamed for not foreseeing its rapid take-up, and certainly not Bill Gates who actually predicted some sort of outbreak back in 2015, but why wasn’t such an event even considered as an outlying risk to investments? In other words, what has been missing? Could it be that the funds management industry and advisers must be included in this, had failed to take a holistic view of risk in the markets?
The good times have prevailed for so long that it seemed almost inconceivable that something catastrophic could happen. Right up until the end of last year, fund managers were delivering upbeat presentations on expected performance and market returns – almost in unison. Of course, there were some exceptions, but very few. It was almost a mutual support society because no-one really wanted to rock the boat by destroying what consumer confidence there was, so everyone felt relatively comfortable with their assessments.
This actually goes to the very core of the dilemma for fund managers. Many specialise in managing specific asset classes and generally do it well. But what happens when severe events are looking likely to impact returns in those asset classes? Do they keep quiet and point to the benefit of longer-term investment horizons, or heaven forbid, should they say to their clients “we think there are dark times ahead, so you should take your money out?” When you read this in print, it almost seems laughable, but it has been done by a very select few responsible fund managers over time.
Bob Kelly, formerly of Eureka Property fame, once said that the worst thing a fund manager can tell their client is that they lost their money. He actually worried about that and the impact it would have on the firm’s clients. How often do we see or hear that in the industry these days? One is tempted to ask: are fund managers always as careful with the investors’ money as they are with their own? Is it greed or, to use the unspoken term of one of the very large global managers: long term greed? Or is it more a fundamental disconnect with the objectives of a manager’s clients?
What is clear is that there is a misunderstanding of risk in the markets and the impact it can have on returns. One of the key reasons for this is that the term ‘risk’ means different things to different people. Ask 10 people to define risk and it’s likely you’ll get at least seven different answers.
This applies, particularly, to the understanding of risk between fund managers and their investors. For fund managers, there is business risk, relative performance risk, peer group risk and reputation risk. However, for investors, the principal risks are loss of capital, poor investment returns or corporate misbehaviour. So, there is not a genuine alignment of risk between investors and their fund managers and advisers. Fund managers should be partners in the wealth creation journey, not excess baggage.
Having a proper understanding of risk should be crucial for fund managers and advisers because, contrary to a simplistic view, risk is not one dimensional as it embraces threat and opportunity. This is important in the investment process because it differentiates the competent managers from the lazy ones. Fund managers haven’t really done anything bad – and they could rightly plead caveat emptor – but it’s just that things could have been done a lot better.
How many times have we seen slides in presentations where fund managers tout their focus on risk (generally at the back of the presentation)? But is this a genuine focus or is it included to tick the box to give comfort to investors? There has been a culture that as long as risk has been mentioned, then the job is done. We know it often hasn’t. This is where groupthink and group behaviour provide a level of comfort, the results of which reinforce themselves.
This is really important because, as pointed to in the Hayne Royal Commission, there has been a very weak approach to adopting and adhering to a genuine risk culture and this has usually led to the current situation whereby investors have been dealt sub-optimal returns at any time of heightened volatility.
It is also worth noting that some big super funds are not immune from this scenario either. As they take management of more assets in house, the potential degree of risk in that process rises significantly. Some funds still comfort themselves with the fact that they employ a piece or pieces of risk management software in their investment processes, so job done. This is disappointing because risk is one of those disciplines where more information is better because the range of issues considered aids better understanding and measurement of risk.
So, we need to ask: will things get any better in the future? If the lessons learned from the GFC are any guide, then the answer is probably ‘not very much’. We seem to have morphed into this situation over time but that is really no excuse.
Until the funds management industry sharpens its focus on the real needs of investors and takes investment risk seriously, genuinely seeking to understand and embrace risk, it seems that little will change. The same mistakes fuelled by groupthink will repeat themselves. The real hope is that the financial services industry will embrace the attitude now adopted by most Australians as a result of COVID-19, that is: “we’re all in this together”.
*Denis Carroll is the partner, Australia and Asia, for CheckRisk, a UK-based global risk advisory and implementation firm.