We are back with our dumb portfolios and their performance at the end of June 2021. The "dumb" portfolios allow us to shake up the conventional wisdom about investing. A little provocation is welcome in a world where we tend to be self-congratulatory.
Reminder
There are three portfolios in CHF, EUR, and USD. Each is composed of two ETFs, one in local equities and one in local government bonds with maturities of 3 to 7 years. At the beginning of each year, the two ETFs are rebalanced to represent 50% of the total portfolio value. The risk profile of a dumb portfolio corresponds to the risk profile of a balanced portfolio that is common in the Swiss private banking industry. It is not an investment recommendation, but a "gauge" to assess the quality of discretionary management in Switzerland.
Why dumb
These portfolios do not require any specific expertise, anyone could replicate them on the banking platforms available. There is no international diversification. There is no story to tell because they are not dependent on market forecasts. They are Pavlovian: every year, you start over with the same allocation and the same two ETFs. In short, they are not sexy.
However, these portfolios have qualities: they are disciplined, transparent, and systematic. They cost only a few hundred francs per year (200 francs or less in custody fees and the fees for two stock market transactions), we can consider that it is a low-cost proposal of portfolio management.
Dumb Portfolios Performances[1]
[1] The performance contains 0.2% annual fee, i.e., 2'000 CHF/EUR/USD per year for an account of 1 million.
CHF | EUR | USD | |
2016 | -1.98% | 4.24% | 6.14% |
2017 | 8.54% | 5.50% | 11.09% |
2018 | -5.29% | -6.17% | -1.89% |
2019 | 13.81% | 15.49% | 18.21% |
2020 | 0.37% | -0.42% | 12.31% |
2021 H1 | 6.89% | 7.72% | 6.70% |
| | | |
TOTAL | 22.95% | 27.80% | 63.87% |
Annualized | 3.83% | 5.03% | 9.40% |
Volatility | 4.96% | 7.86% | 7.72% |
Two ETFs for each currency
UBS ETF (CH) - SPI® (CHF) A-dis CHF ISIN: CH0118923892
UBS ETF (CH) - SBI® Domestic Government 3-7 A-dis CHF ISIN: CH0131872431
iShares Euro Government Bond Index Fund (IE) Class D Eur ISIN: IE00BD0NC037
iShares Core MSCI EMU UCITS ETF EUR ISIN : IE00B53QG562
iShares $ Treasury Bond 3-7yr UCITS ETF ISIN: IE00B3VWN393
iShares Core S&P 500 UCITS ETF USD ISIN: IE00B5BMR087
“Dumb portfolios” benefited from the rise in equity markets in 2021. Like the industry and unlike previous years, year-to-date performance is similar in all three currencies. Volatilities are returning to normal, after an exceptionally turbulent 2020.
To measure the quality of a performance, it is best to consider a period of 5 years or more. Thus, the performance of the “dumb dollar” is significantly higher, in local currency, than that of the Euro and the Swiss franc, almost 40% over 5.5 years. This is since “dumbs” only invest locally. Yet US assets have significantly outperformed those of Europe and Switzerland over the period under review. Since there is no currency diversification in “dumbs”, the CHF and EUR portfolios have not benefited.
How does this compare with the industry?
It is not our intention to provide a detailed review of the performance of the private client investment management industry. We rely on the risk-adjusted performance published by the excellent community platform "Performance Watcher" (PW), the only one that is totally independent because the data is not used for any other purpose. It aggregates the results obtained, by currency and by risk profile, for numerous discretionary portfolios of private clients.
Since 2016[1], dumb portfolios do slightly better than the PW average portfolio medium risk in CHF and EUR, and much better in USD. The volatilities are similar, although the dumb in EUR and USD, have a higher volatility than the average of PW in 2021. Everyone can consult these figures on www.performance-watcher.ch .
We claim that “dumb” portfolios are easy to beat, so why do professionals have such a hard time beating "entry-level", finance-for-dummies type portfolios?
[1] Except for errors and omissions, official figures can be found at www.performance-watcher.ch
| CHF | EUR | USD |
2016 | 2.33% | 4.22% | 4.12% |
2017 | 7.94% | 5.71% | 11.15% |
2018 | -8.08% | -7.18% | -7.06% |
2019 | 11.62% | 12.58% | 15.16% |
2020 | 2.11% | 3.09% | 8.49% |
2021 H1 | 5.97% | 5.77% | 5.35% |
| | | |
TOTAL | 22.64% | 25.53% | 41.57% |
Annualized | 3.78% | 3.48% | 6.09% |
Volatility | 4.123% | 4.94% | 6.02% |
The promoters
Most financial institutions and financial intermediaries have competent staff and the infrastructure. They therefore have the knowledge and the means to achieve results for their clients. A priori, one cannot question the willingness of the managers of banks and institutions in the private banking industry to deliver above average results.
So how is it possible to struggle to do better than “dumb portfolios”, so simple to implement, over a 5+ year cycle?
The answer is simple: most of the industry is not in the business of investment, but in the business of investment promotion, which is fundamentally different. Because if one needs performance for the clients, one also needs revenue for the suppliers. There is a conflict between these two objectives.
To be credible in this industry, one must make forecasts on the evolution of prices of everything, all the time. This is a self-imposed constraint, but it allows for portfolio movement, launching new funds/products with good margins, or changing portfolio allocation, which generates revenues.
Today, thanks to the mega-topic of fighting global warming, everyone is vying to bring new products to market that allow their clients to invest in a more "responsible" or ESG manner[1]. However, it is rare to have information on the costs of these products and how they will be integrated into portfolio allocation. Responsible finance is not only about buying "green" or “responsible” products, but also and above all, about reducing the number of transactions and providing full transparency on the fee structure.
Top Management is keeping a close eye on the "return on asset" (ROA) of client portfolios. It is how much each portfolio is earning for the institution. Having profitability objectives (ROA) is a constraint that comes at the expense of portfolio management quality. By running with chains on your feet, one can have satisfactory results over 1-2 years. Nevertheless, over long periods, one is condemned to obtain lower returns. Promoters are doomed to underperform.
Useful Utopia?
No one can predict price movements in the financial markets, not even the best investment banks on Wall Street.[2] We know it for a long time. That is what is so great about our industry, is that it can make you believe that a good portfolio manager must predict what the markets are going to do in order to allocate capital. In fact, these forecasts are useless at best.
How do you recognize a promoter?
In the portfolios of promoters' clients, in-house products, structured products, and retrocession embedded products are often over-represented. There may also be a high annual turnover; the total of the transactions frequently exceeds 50% of the value of the assets under management each year, not to mention the often-costly foreign exchange transactions.
Promoters also propose new trades every day to be implemented in portfolios, which is the exact opposite of investing, and unfortunately it is not trading either, some consider it "Advisory". Advisory should be organized around portfolio construction issues. What is the impact on the risk when moving the portfolio ? Or on the expected return of the asset allocation? Under which scenarios? A few transactions per year are enough.
So, what is the purpose of a portfolio manager?
A good portfolio manager is a portfolio builder. According to the needs of the clients, the investment vehicles are chosen carefully and vary little. His compensation is not indexed to the ROA of the portfolios he manages, this has been fixed at the beginning of the relationship with the client. He is focused on mixing the best available investment vehicles according to the criteria previously defined with his clients. He looks for robustness in his portfolio construction. A well-constructed portfolio is convex, it participates more in market upswings than in market downswings; this seems trivial, it is not.
A good portfolio manager does not waste time trying to predict the next move in the market, on the contrary, he protects his clients from the sometimes-dangerous hubbub of the financial media. He favors the long term; he is disciplined and transparent. His reporting allows the client to judge the quality of the results obtained in absolute and relative terms and based on qualitative criteria defined in advance with the client.
Shared responsibility
It must be recognized that it is also the responsibility of clients to put in place quality control tools for the results obtained by their manager and the institution he or she represents, even if the manager is a friend and perhaps especially if he or she is a friend. The latter does not even need to know that he is being audited.
For a few years now, there have been inexpensive and systematic monitoring solutions. This allows you to ask the right questions to your manager and quickly detect any inconsistencies.
If the quality of the results is not good, it must be corrected quickly, If not, over the years, the financial shortfall can be very important (in million).
We have one clear recommendation for clients: make sure your portfolio manager's interests are aligned with your own.
An opportunity
It seems to us that with the entry into force of the FinSA and the rise of sustainable finance, Switzerland has a great card to play.
There is room in the private banking industry for a high value-added service, which would emphasize portfolio construction know-how for capital preservation and growth.
The relationship with the client should be based on a charter of commitment. Transparency on fees and on the quality of the results obtained is essential in such a relationship. It is of course a question of defining what the value proposition of each entity is, according to its resources and skills (spare us the bespoke management and confidentiality stuff, which are found everywhere and are never documented). The proposition must be high value added, paid for as such. The "promoter" model is outdated, we must evolve. The 90's are long gone, knowing moreover that decentralized finance has the potential to further change the wealth management landscape in the coming years.
If you want to modernize your value proposition as an investment professional, or as a client to implement controls, or simply to criticize the above position, please feel free to contact us: jsp@premyss.ch.
[2] We recommend that everyone (re)read a basic book for any investor: "A Random Walk Down Wall Street" by Burton G. Malkiel