The investment manager’s job should be to...
 

‘I had rather be a kitten and cry mew
Than one of these same metre ballad-mongers.’

Henry IV Part I

Over the past 17 years or so, these occasional reflections have set out to explore the investment hinterland, rather than terrain well marked by routine comment and conventional analysis. A financial observer may view the sweep of history and world events as his proper concern, but his employment often rests on daily transactions and hour-to-hour price movements. So horizons get shortened and commentators find themselves covering their ground like the 4 x 4 drivers who cruise into the carpark of Surbiton Safeways on a Saturday morning, flashing bullbars and the promise of adventure and discovery. Most never leave the M25.

Successful investors avoid the crowded road and its drone of consensus, knowing that their opportunity lies in the lonely place which few frequent and fashion never visits. Such has been our preferred destination. Yet if our patient readers have found themselves far from the well-worn track, it is puzzling that they seem to have missed it so little.

All of them, naturally, are courteous to a fault, and any who would have liked their investment divinations to come with more crunch and less hunch have declined to say so. There is more to this than meets the eye and, in the course of digging for the reason beneath our readers’ extraordinary complaisance, a little nugget has come to light.

People do not miss the market tip or the trend for tomorrow because they never believed it in the first place. They read short-term financial forecasts rather as they listen to the Archers – to add a dash of romance and excitement to a working day, to share the latest twist in the plot with their friends at drinks parties. Nobody believes it’s for real. ‘FTSE to plummet today’ – forget it, it probably won’t. ‘Japan’s recovery boosts Nikkei’ – maybe, maybe not. ‘US trade deficit to collapse dollar’ – it could, but there again, it hasn’t. The truth is that from day to day, financial commentators – and that, dear friends, is us – have not the foggiest idea whether a given market price is likely to go up tomorrow, or fall, or neither. Why not? Because big markets are highly efficient and today’s price for the dollar, for Shell shares, for gold, for wheat, for oil, already reflects the knowable relevant factors.

Over longer periods – months or years – judgments can be made and acted upon. At a company level, able people tend to go on doing the right thing, ninnies the reverse; industries wax and wane; new economic frontiers in the Far East or the old communist bloc open up. Such trends offer investment opportunities over the long pull and they can be exploited. But if you are hoping to find a reliable tipster for a day or two at the financial races, dream on.

Since most investors seem long ago to have recognised the shortcomings of financial punditry, they may come to wonder what, if anything, an investment manager actually can do for them. Happily there is a positive answer to this enquiry.

The first responsibility of an investment manager is to protect his clients’ standard of living. For clients with relatively modest resources this generally means trying to ensure that their investment income keeps pace with the cost of living. In stable conditions when consumer prices are rising at 2% or less, this is relatively easy. In these circumstances, investments should be regarded as fixed assets whose capital value is more or less incidental to the income they produce. Indeed, this was the way that Scottish investment trust managers looked at their portfolios for much of the twentieth century, right up to the 1950s.

It is also the manager’s responsibility to preserve the real value of a client’s capital. Note the word preserve. The job starts with protecting what is there, not exposing the substance to financial hazard as a means of securing some anticipated reward which may never be realised.

If one were simply looking ahead over a few months, protecting the real value of a financial portfolio would be simple enough when even building society interest covers the increase in the cost of living (depending, of course, on how you measure that). The problem arises when one looks beyond the immediate to plan, as a responsible manager must, for a period of a generation or so. Today’s stable prices can take off into a roaring inflation within a few years; an inflationary boom will almost certainly end in a recessionary bust. So an investment portfolio needs to be sensibly diversified. It is the manager’s job to see that it is.

It is at this point of spreading the risk that a manager should be able to add value, above all by preserving a sense of professional detachment. His job is to stand clear of the fads and fashions that impel savers to throw billions of pounds into index funds one year, billions more into technology shares or split-capital investment trusts the next, and yet more billions into hedge funds after that; he will know that it is not possible for millions of investors to scramble through the same window of investment opportunity at the same moment. Investors drawn by market fashion are like adventurers on the trail of treasure hidden in a remote cave. The far-sighted ones glimpse the opening first and make their way through to plunder the chest. Others follow until even the stragglers find their way in. But by then the spoils are gone and, as the latecomers turn to retreat, they find the opening narrowed to a slit by the press of bodies trying to exit. Many perish in the crush. Managers do well to keep their clients out of crowded caves.

While managers tend to exaggerate their ability to anticipate short-term market movements, they fail to underline the importance of their administrative responsibilities, one vital area of their operations over which they truly can and ought to exercise full control. By administering a client’s affairs efficiently, so relieving him or her of the fuss and bother of planning and collecting income receipts, settling bargains, keeping the records and generally looking after the paperwork, a manager provides a service of real value.

Objective standards of performance and delivery may go so far in assessing a manager’s basic competence, but ultimately the only measure that counts is the contentment of the clients themselves. The tangible results of their manager’s efforts – whether that means rich rewards or painful loss – will, of course, have a bearing on that. But just as important is the level of understanding and trust between them. Sheer misunderstanding or ignorance of what a manager is doing breeds more discontent than any other factor in the relationship, and it is no excuse to claim that clients don’t want to know or can’t understand. A manager’s job is to ensure that clients do understand what he is trying to achieve, what the financial statements mean, what the characteristics of a financial product add up to. The essentials underlying financial choices are not difficult to grasp, and all too often the apparent indifference of many private investors reflects the failure of financial service providers adequately to explain and inform or, worse still, a tendency to obfuscate the basic issues.

Confidence in a professional relationship depends, as in an enduring marriage, on the accumulation of small things done well. It is a rope of fine threads that ties expectation to recorded achievement. Without it, clients are left with nothing to hang on to when anxieties mount.

A few weeks back, the BBC’s gardening philosopher, Monty Don, was asked about his recurrent bouts of depression. He gave a moving account of his dread of winter and the January days which wrapped his spirit in a black shroud. Yet even in the darkest days he said he managed to hold on to a glimmer of hope in the knowledge that the light of a new spring lay just below the surface in a bursting bulb.

It is the investment manager’s job to build a relationship that is strong enough to look with the eye of reason through the market’s vicissitudes towards the spring of new growth. That is not done by trading glib forecast and empty expectation but by striving towards the ends which sound management is capable of achieving. Knowing one’s limitations is a good start on the road to success in any profession, and it is sensible to declare them. When they do, investment managers will find that the only surprise is that there is no surprise.

1 September 2004

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