Thursday, September 5, 2013

Think investment policy first, not just NFP

As the financial world holds its breath and waits for the US jobs number release, I thought that it would be instructive to put some context to the process of investing. Too often, people get overly distracted by the latest economic release, or about what's happening to the latest hot stock and don't pay enough attention to why they are investing.

Here is an example. I recently spoke to a serial entrepreneur who had sold one of his businesses and netted a substantial sum of money. It has been sitting in a bank account receiving daily interest and he didn't know what to do with it. He is financial well established, has several children and grandchildren. As part of his tax planning, he moved some of the funds are into foundation(s). He then complained that he and his wife had been inundated with proposals from private bankers and financial advisors but found many of the proposals overly self-serving. He was simply at a loss of what to do.

I had a number of suggestions for him.

Establish personal objectives
First, deal with the soft issues, which is perhaps the most difficult at a personal level. Since he is well established financially, he has to figure out what to do with his legacy and how it is handled. This involves getting into a serious discussion with his children and possibly his grandchildren about the topic. It's a sensitive issue of family dynamics that he has to deal with.

As well, his wife, children and grandchildren need to get educated about wealth (see my recent post Passing the generational torch). Education happen at two levels, motivation and knowledge. The most important aspect is motivation - how do you motivate a 25-year old guy to invest his legacy and make wealth grow instead of treating the funds as a source of spending and blowing it on a Ferrari?

In addition, members of his family need financial literacy, the first line of defense against scam artists. There are many advisors out there. Some will be out and out fraudsters. Others either don't know any better or think about how they can generate commission to benefit themselves.

In other reading, Dana Anspach recently wrote a must read article addressing these and other issues called 10 ways to wipe out your retirement savings.

Everyone has to take responsibility for their own finances.

Establish financial objectives
The second broad set of advice I gave him was to establish a board for his foundations. The board members, who are now held to a fiduciary standard, should then set an investment policy for the foundations. Make sure that the board members don't have conflicts and they aren't trying to sell him something.

I added that, in my opinion, that stocks are likely to disappoint as an asset class until the end of this decade (see my blog post A new secular bull? Don't count on it!). He will have to live with a low return environment for the time being and that he shouldn't try to be a hero, at least for now.

In terms of setting investment policy, I am a great fan of using an asset-liability management (ALM) framework for pension funds and foundations. The proper approach is to create a custom liability benchmark and then set investment policy in accordance to that benchmark. The custom liability benchmark is a way to force the organization to define its investment goals in an explicit way. Variance from the benchmark is considered to be active management and needs to be justified.

In short, don't think so much about what is going to happen with hot stories like Tesla or Apple. Focus first on investment policy and all your other decisions should naturally flow out of that framework.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

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