Rather than measuring active fund management on absolute returns, advisors should consider liability driven investing (LDI), suggested panelists at the Toronto Stock Exchange ETF lunch and learn on Tuesday.
Institutional investors, such as pension funds, are more concerned about liability than beating a performance benchmark, said Som Seif, president and CEO of Toronto-based Purpose Investments Inc. That same framework should apply for individuals, he said, but the manufacturers are often focused on hitting a benchmark.
LDI is an investment strategy used by pension funds or individuals based on the cash flows needed to fund future liabilities, such as retirement.
Raj Lala, president and CEO of Toronto-based Evolve Funds said the industry has not done a good job of teaching investors what to look for in an upmarket.
“When the benchmark is up 10% and their underlying investments are only up 7%, [clients] are wondering why they underperformed. When the benchmark is down 15% and they are down 5%, they want to know why they lost,” Lala said.
“Unfortunately, we’re in an environment where everybody wants to have their cake and eat it too, so they want to look at relative when we’re in positive performing markets and they want to look at absolutes when we’re in declining markets,” he added. “And we need to do a better job of educating investors on that fact.”
Seif suggested that reporting could be upgraded to better educate clients. As it stands, reporting is on trades, executions and market indexes, but it doesn’t include liability. “If the first thing you saw every single time you looked at your reporting was a 7%, 8% or 4% liability, and you either over or under funded to that liability, people would anchor to that principle,” Seif said. “They wouldn’t care what the S&P 500 was doing last year or last quarter. What they would care about is they are under- or over-funded to their goal.”
“Everyone anchors to the only data points they have, which is the market benchmark,” he added.
As a result, advisors sometimes don’t want to put their clients in emerging markets or small mid-cap funds because of how clients react when they look at their statements,” Lala said.
“If [clients] scroll all the way to the bottom and they see that they lost $500 on an emerging markets fund that was down 22%, it’s just not worth the aggravation because the flipside is you don’t get a lot of accolades if it’s up 22%,” he saids.
Jay Aizanman, director of strategy and business development at Montreal-based Desjardins Global Asset Management, added that it’s important to talk about risk when discussing benchmarks. “Addressing your clients risk tolerance is not their risk of loss, necessarily, it’s how much risk they are willing to absorb on a volatility basis.”
Aizanman suggested converting a client’s goals into a liability. “If you can convert their fears into a number and then manage,” he says, “then you can have a whole set of discussions with them. Rather than worrying about emerging markets, you worry about what the risk is of taking this, and then you’re addressing a different conversation.”