Clients need strategies that manage volatility

One of the biggest issues faced by people trying to invest for later life is a lack of understanding when it comes to how much money they need to achieve a certain standard of living - and how they are going to get there.

This problem is exacerbated by the use of arbitrary, and often short-term performance measures.

Fund managers work to generate returns by focusing on market benchmarks or comparisons with peer groups

The investment manager of a fund may be very skilled and do a good job against a certain benchmark, but the problem for investors is that the benchmark’s returns do not speak to their needs.

To address this, investment strategies must be built on targets that people understand and can relate to their own life.

The traditional model of investment management has remained largely unchanged for decades.

Typically, fund managers work to generate returns by focusing on market benchmarks or comparisons with peer groups as a way to validate the effectiveness of their performance.

However, the economic and political upheaval we have experienced in the last couple of years has made the markets far more volatile, creating a bumpy, nervy ride for investors. Conventional investment strategies often fail to prioritise the needs and goals of investors.

With this is in mind, we should arguably be moving towards strategies which manage volatility and soothe nerves by taking a longer-term approach with less undue risk. These investment approaches should also focus primarily on achieving specific outcomes that align with people’s life goals. 

Arguably, what most investors seek is something that lies neatly between traditional market investing and the guaranteed returns experience provided by something like a pension annuity. Outcomes-based investing bears some of the hallmarks of both approaches. 

For example, the performance outcome targeted is a return in excess of inflation through the cycle.

Additionally, it focuses on making the journey to the outcome as palatable as possible.

This provides a number of benefits such as reducing sequencing risk (the impact of poor performance on wealth, especially when the assets are at their largest) and perhaps more pertinently, the smoother the journey to the outcome, the greater confidence felt by investors - which helps them to stay the distance to achieve their necessary investment goal. 

With a large amount of uncertainty out there at the moment and a cacophony of background noise, it is important that investors' journeys are made comfortable in order to help them stay invested until they reach their desired investment outcome. 

Clearly no investment strategy is immune from market forces but intelligent asset allocation with plenty risk diversification, that has a good probability of achieving the investor return goals, should help. 

Time horizons are very important when it comes to both portfolio risks and returns. 

As a result, an investment strategy that increases the chances of clients staying invested should result in a suitable risk experience and provides the best chance of achieving the desired outcome. 

This is especially important as so few investors can afford to let their capital drift for them. 

Therefore, finding the right balance between capital growth and portfolio risk is crucial.

If the journey to the outcome is too rough, even if the long term expected returns may be great, the chances of investors sticking through the tough times are lower.

This approach to risk management, especially focusing on downsides, which investors feel more acutely than comparable gains, should help to keep clients invested through good times and bad. 

Outcomes-based investing also often exists in a risk-rated environment and this helps investors to understand, both at the outset and on a continuous basis, the ‘riskiness’ of their fund and compare that to their appetite.

 An investor’s needs must always come first and although they loosely fall into one of three categories - the essential need to survive, the lifestyle wants and the future legacy aspirations - they always differ enormously from person to person.

The outcome-based journey enables an investment plan that is tailored to each and every investor - detailing everything from the time it will take to achieve their goal to the milestones they will meet along the way.

It is not just investors who are seeking more meaning from their financial solutions.

A couple of years ago the FCA cautioned investors about the dangers of schemes focusing on critical yield or other comparisons using generic assumptions for hypothetical returns.

Independent of the various issues associated with the critical yield approach, the simplicity of an outcome-based solution is that it distils the investment objective back to what is meaningful to the customer. 

The current generation of workers have extremely challenging times ahead and the majority will need to make sound financial decisions to achieve the quality of life they are hoping for in their later years.

Central to this should be the adoption of outcomes-based, jargon-free investment options and there is also no reason why the same approach cannot be applied to all aspects of managing one’s finances.

Whether it is mastering everyday spending or a creating a long-term investment strategy, all actions should follow the same route to achieving financial wellness and specific financial goals.

James Klempster is director investment management at Momentum Global Investment Management