Prophets and profits: Investment doctrines explained

Investing is a broad church. While nearly all investors follow the one God of “Capitalism”, there are many differing beliefs about what works and doesn’t investing. To help you select from the proliferating range of product offerings, here we summarise the different beliefs Australian investors follow knowingly or not.

Proliferating investor offerings

Figure 1 summarises the underlying investments investors rely on to generate a return on their assets. Essentially investors seek returns from (1) rent and property appreciation, (2) corporate profits and related company price appreciation, (3) interest on money lent and (4) speculative price rises. Which of these areas, how much, and how they are accessed depends on your, or your partner’s, beliefs.

Over recent years the range of investable assets has proliferated. Low-cost index funds (unlisted or listed exchange-traded funds (click here) track more indices. New rules allow more actively managed funds to be listed, complementing the availability of listed investment companies (LICs). Investors can now locally buy and sell shares in overseas companies as well as bonds bought through a broker and now on the ASX. Gold and other commodities can be bought in more forms than they exist. With so much choice, investors need more than ever a belief set to guide what to buy and not or who to choose to help them do so.

Figure 1: Investor asset offerings: underlying assets and various types/features

Click to enlarge

Path dependent beliefs

Only about a third of Australian investors would be considered “Do It Yourself” (DIY) investors practising their own beliefs. Therefore about two-thirds of investment decisions are influenced by or are entirely dependent on the belief set of others. I call the former group who seek assistance, especially advice, but don’t surrender control: “DWY” or “Do With You” investors. The latter group, “DFY” or “Do For You” investors, rely completely on others to invest for them and their beliefs.

Figure 2 lays out a decision tree of sorts that creates different investor pathways to underlying assets. While you might say its complexity captures why some investors feel they and their money gets bounced around like in a pinball machine, this just reflects the wide variation in beliefs about what works and doesn’t investing (and how others believe also they can make money).

Figure 2: Investor pathways to underlying investment assets showing also the % of investors by pathway and the % on average allocated to underlying investments.

Click to enlarge

Source: Professional Wealth and Wealth benchmarks (www.wealthbenchmarks.com.au)

DFY Investors

Aside from the small group of investors who choose or are blessed to be able to opt out of making ongoing investment choices, the bulk of DFY investors invest in multi-asset funds run in-order of size by (i) industry-funds, (ii) government and a declining number of employers and (iii) financial institutions (so called “Retail”). All of these “DFY” fund providers believe strongly in the benefits of diversification implemented mostly through a cost-saving, Goldilocks’ choice of low, medium and high equity-mix funds. These funds follow high priest Asset Consultants to help them allocate and pick active and index style fund managers. The larger industry and government run believe also in “patient capital” or in an “illiquidity premium” and invest in many unlisted assets for their more passive investor-member base. Retail and smaller corporate funds restrict their investments to more liquid investments out of necessity or believing those risks aren’t rewarded.  

DWY Investors

“Do With You” (DFY) investors seek assistance making and implementing their investment decisions. Often when seeking advice from someone employed by, or affiliated with, a product provider a house investment product or administration service will be recommended. These organisations believe these solutions are more than adequate to meet investor needs and reflect the greater commercial chance of making money, or recovering costs, from scalable products than expensive people.

Many previously product-independent advice organisations, such as Shadforth (soon to be owned by product provider IOOF) and Dixon, have adopted this belief in “vertical integration” introducing their own “house funds”. Small firm, independently-owned boutique advisers believe that by being product agnostic they offer more conflict free advice. The divide between institutionally aligned advisers (about 90% by number) and those in smaller non-aligned firms (about 10%) arises from different appetites and capacity of advisers to have their own license or source their own clients.

Within the “DWY” segment are stockbrokers and their investor clients who hold a strong belief that investments bought on the ASX are more than enough to satisfy. Traditionally this made for an over reliance on top 50 Australian shares and hybrid securities, but with the emergence of listed ETFs this no longer has to be the case. Some non-product aligned advisers use managed accounts (MDAs or SMAs) to offer a similar but more uniform service, blurring the lines between them and stockbrokers. Together brokers and these advisers have faith that it is possible to pick winning, and avoid losing stocks, and that trading is rewarded more than a buy-and-hold dogma.

Though not shown, bond brokers and a small minority of concentrated bond investors believe financial security can be met lending money to others. Also not shown, accountants used to believe in tax effective, managed investment schemes (MIS) but after investors were crucified those beliefs have been rescinded.

DIY Investors

Being free to enjoy a wide range of beliefs, it is not surprising that many different asset allocation biases and investment styles are adopted. In a sermon last year I suggested that property is an optional asset allocation. Because property is also an expensive “lumpy” asset, differing beliefs about property divide DIY investors.

About 5% of Australians, feel comfortable investing solely and directly in property - mainly residential property and often with debt. This love of bricks and mortar can be passed on through family belief and may be based on a deep suspicion of the purity of shares or institutions. Conversely others vow to not own any investment property, disliking being a landlord or worry about valuation.  A few instead are happy to concentrate their wealth in shares, willing to forgive their large swings in price and enjoy more steady dividends.

Most DIY investors however practise some form of diversified investment. A few wealthy follow three-thousand year old asset allocation advice and divide their assets one-third into property, equity and cash. Others get their exposure through listed or unlisted commercial property trusts. Because of these differing views, the ultimate allocation of investors to property cluster into four groups allocating about 90%, one-third, 10% or nil.

More than ever individual investors are disciples of high dividend paying stocks including bank shares. With $500 billion invested in the equity and debt of local banks and $800 billion deposited, could this be idolatry? Rather than designing portfolios for income I suggested in Allocating for income that investors consider living off the total return of their portfolio.

Gold bugs don’t invest; they simply buy insurance against the collapse of the organised religion of investment.

Fund managers

Investors use fund managers because they find it difficult to access certain investments directly (less necessary now), because they believe a broad diversified (sometimes index) mix of assets is the right way to invest or because they believe in the predictive powers of active-style fund managers (gurus?) and their methodologies to pick stocks and/or time markets. Those who avoid fund managers have a strong belief in either the virtue of eliminating their fees or in their own powers of portfolio assembly.

Index fund managers believe in the doctrine of Efficient Markets, which maintains that security prices do a good enough job valuing assets. Active style fund managers disagree but have differing beliefs on how best to pick shares. Within equities, “Growth” or “Growth at A Reasonable Price” (GARP) managers believe that companies that have performed well will continue to do so. On the other hand “Value” managers believe out of favour companies trading on low valuations will one day come to the top. Often when a fund manager is performing well it may because their chosen investment style is temporarily in favour (such as income and imputation styles now) and not because of special insights.

Some managers follow megatrends and “top down” pick stocks while others “bottom up” build portfolios of companies they like. Traders believe patterns in the sharemarket reappear from time to time perhaps originating in human behaviours like fear and greed. Fundamentalists believe in predicting the future from the entrails of annual reports and management inquisition.

“Long/short” managers believe they can also pick stocks destined to fall, soon. A few write derivative contracts to enhance income, suspicious of upside gain. Many structured products are marketed on the belief that downside protection must be free.

Within the bond market, some funds lend money to companies with good and others not so good credit ratings - the latter called “high yield” (junk bond) funds. Some managers focus strictly on a sub-class of bonds like fixed-rate, floating-rate or inflation link bonds while others would have you believe they can add value moving between different debt securities. If you have strong beliefs about how to build your defensive portfolio then you need to work with the former.

Hedge fund managers adopt many different theologies but practise the same rite of overcharging. 

Some investors and advisers believe they can spot peaks and troughs in the market and vary the mix of assets in a portfolio using “tactical” (TAA) or “dynamic” (DAA) asset allocation. An alternative view is to adopt a more rigid “strategic” (SAA) allocation and rebalance to a fixed or life-stage varying mix.

We should point out that, unlike you, there are “Investment Atheists” who worship the God of Consumption and live off the tithes of others. Hopefully after reading this investor and industry review of beliefs you should be able to make a more enlightened decision about how you choose to invest and with whom. From now on don’t be afraid to ask yourself, and those you place your trust in, “What do you believe?”

Dr Doug Turek is Managing Director of independently owned advice and money management firm Professional Wealth^© (www.professionalwealth.com.au). Previously Doug was the Asia-Pacific funds management expert with The Boston Consulting Group^©. Estimates of industry size have been derived from that experience, publication and DIY-benchmarking at Wealth benchmarks®  (www.wealthbenchmarks.com.au).