When markets enter the later stages of a bull run — as appears to be happening now — it isn’t unusual for investors’ perception of risk to shift, especially when “buy the dips” becomes a common mantra and volatility is being compressed.
In our own interactions over the past few months, however, we’ve noticed that this perception of risk varies dramatically depending on demographics, with those who have experienced a market correction or two remaining a lot more cautious than those who have just started investing over the past 8 or 9 years.
In particular, the vast majority of older investors at or near retirement age are simply looking to generate a reasonable return while protecting their capital instead of trying to keep up with the market. While our typical client has a high net worth and therefore a greater ability to take on risk, we’ve noticed that their willingness remains moderate despite all the euphoric headline reporting.
Forward looking markets aren’t buying bullish takes on the Canadian economyInvestors may have brushed off the correction, but the risks are still realThree key takeaways from the market shock that will help investors navigate stormy waters
Given the low-rate environment, most would be satisfied with generating a 5 to 6 per cent rate of return while taking on as little risk as possible to get there. While this means having to own fewer bonds, the fear of being overexposed to equities has left some wondering just what a balanced and well-diversified portfolio should look like in today’s environment.
This outlook differs significantly from that of the younger generations, for whom tracking the market has remained very important. That includes capturing the gains from the tremendous performance in U.S. equity markets over the past few years as well as last year’s rally in international equities.
For younger investors, this approach has often meant eagerly embracing the use of low-cost exchange traded funds, even those that are a bit exotic in nature, such as those investing in artificial intelligence, robotics and automation, marijuana and cryptocurrencies.
Interestingly, we’ve also noticed that this do-it-yourself approach and high level of self-confidence has led to the desire to own individual deals, rather than participating in actively managed specialty funds that often have a higher fee attached to them.
For a family office, managing such a range of risk perceptions within a single family can prove challenging, as the next generation often views their parents’ portfolio as being far too conservative and too costly in terms of fees.
The problem is that this perception gap will not narrow until this younger generation experiences a market correction like their parents, who lived through the challenges of record levels of inflation in the 1980s, the tech bubble bursting in 2000, and the 2008 financial crisis.
Fortunately, the management of this wealth has not been yet been transitioned downwards and control for the most part remains at the parent level. That said, as any parent of a teenager knows, the best way to teach a life lesson is by letting them learn through personal experience while preparing in advance behind the scenes to keep any potential damage to a minimum.
Therefore, we think now is a great time to teach the next generation about the risk versus return relationship and a great way to begin is involving them in meetings with the family’s wealth manager.
For example, this could mean having them participate in deriving a formalized investment process and then allocating a small portion of the overall portfolio into riskier investments including private equity and debt, venture capital, and even new technologies.
The ideal situation would be each family member learning from the other and working together to improve the dynamics of the management of the family’s wealth. For example, we’ve seen a lot of positive change in the way a family’s portfolio is being managed with a combination of institutional active portfolio managers, passive ETFs, and risk-managed funds with a little excitement added via alternative investments such as new technology funds and/or private equity.
Finally, when a correction happens — and it eventually will — the younger generation will gain the ability to understand the true relationship between risk and return and know how best to pass this wisdom along to the generation below them.
Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.