I just wanted to pick up on an article by Michael Nairne in the National Post, “How to avoid the dreaded return gap”.
The point that investors are being short changed by ill discipline is an important one, whether it be advisor driven or client driven. These are all suitability process issues, and hence fiduciary type responsibilities, that advisors should be bringing to the table irrespective of whether they are providing advisory or discretionary service.
The incentive to provide these services is much reduced under a transaction return model: if you are implementing service structures that inhibit transaction responses and limit transactions, while being remunerated by the transaction, you are going to cut your own throat. You need to be able to charge for the work you are doing, which is providing disciplined, low transaction investment planning and management.
Cary List, an OSC Investor Advisory Panel member, talks in his mutual fund fees submission of, what I presume is, a fee based planning model cohabiting with a transaction return model; what he was really talking about was a model that would focus on advice and service that would eventually push out the transaction to the margins, which would itself emphasize low transaction costs and bring about the end of the transaction driven advisory industry.
It would therefore have been nice if the article could have drifted towards advisor as opposed to investor actions. You have to go through your Hegelian moment before you can accept the simple truth, which is also why we need institutional/firm level accountability for the actions of advisors.
I disagree with “money being left on the table” though: one person’s loss is another person’s gain. Without people selling low and buying high, rebalancing returns for disciplined investors would be smaller. But, if your target allocations reflect unrealistic risky asset return expectations, you may end up doing the same thing: that is holding more overvalued assets relative to undervalued assets. I would therefore add that too many MVO structures had unrealistic equity return expectations at the back end of the 90s, and onwards, and as such you can just as easily get hit by the wrong discipline as by none.
I know many eschew the “active” these days, but I think it is important that we also combine valuation driven disciplines with the more passive structured asset allocation and rebalancing parameters. I do not think that the two are incompatible.
I would also be very careful with rebalancing. The most important aspect of rebalancing within a passive investment structure is risk management. That returns can also be garnered, and risk reduced, by rebalancing also suggests that markets are not perfect and move to and from relative and absolute high and low valuations. But you need to be careful, since selling an asset equidistant between its equilibrium and eventual high valuation and buying an asset equidistant between its equilibrium and its low valuation, will result, inter alia, with no return benefits. Rebalancing benchmark widths are therefore important, and the wider the benchmarks the greater the allocation risk. You need to rebalance when an asset is further along its relative and absolute valuation movement, in other words you need to focus on significance!