Chief Exec of Pimco and a FT commentator, Mohammed El-Erian believes that investors have lived the past 20 years under a belief where investment rules of thumb worked. 

But no more!  The past is no longer a guide to the future (if it ever was). 

Instead, he says, the dispersion (or variation) in policy-maker’s expectations is unusually wide for basic economic variables such as growth and inflation and the likelihood of policy mistakes (such as interest rate or tax & spending policy) is greater than it has been for the past 25 years. 

As a result, few investors are likely to see ‘average returns’ on their investments. Instead, some will perform much better than the average and some will perform much worse. 

Which begs the question; can this be the fault of the investment manager? And if not, on what basis does the wealth manager recommend investments or pension funds to his or her clients? 

Tough investment questions don’t go away

Okay, let’s firstly acknowledge that the decision or recommend or select an investment manager, pension fund manager, unit trust or other collective investment has always been a tough decision. Nothing new here. 

However, for many years onshore and offshore wealth managers have been able to back up their investment decisions (and in many cases were legally required to do so) with evidence of past performance. 

If past performance is becoming less and less linked to future performance what does the wealth manager do? 

What now counts as a good reason to select an investment manager or product’? 

El-Erian goes onto explain some more 

1. Fluctuations in price will increase / widen and this will create short term investment opportunities (and risks).
2. There will be a gradual movement away from assets where the predictability is reduced, such as equities, along with a greater desire to hold liquid assets and this shift in demand will drive prices accordingly.
3. Historical benchmarks will be challenged and broken, so investment strategy will need to begin with first principles.
4. Some investments will simply melt-down, we’d better get used to this
5. Asset diversification is no longer enough to reduce risk.

El-Erian is telling us that we simply need to invest from first principles (or current strategy), not on the basis of past performance and that we need to find a way to more actively manage our investments. 

Or to put it another way, if your share goes up more than you expected, sell! It is probably a happy accident that will be reversed. 

Equally, if a share falls more than expected – then consider buying (slowly), as it might be an unhappy accident that will be reversed. 

Conclusion

The critical conclusion here is that there is less and less benefit from the traditional buying and hold strategy. When a stock, asset or investment index reaches an unusual or unexpected high, sell it and take profits.

 Therefore, passive investment vehicles, such as index tracker funds, are unlikely to deliver decent returns (or even average returns) for the level of risk taken. 

Hence, active management, with a clear investment strategy is the best route forward and proactive wealth managers are in an ideal position to help their clients. 

Diversification (and hence risk reduction) will only be achieved not by investing in different assets classes but by investing in different investment strategies.