ICPA Analysis: Roddy Kohn on clients' investments

A modern approach

Roddy Kohn discusses the various approaches you can take with your clients’ investment funds

As I write, US Federal reserve officials have lowered their outlook for US economic growth in 2012. With forecast unemployment in the US averaging 8.5%-8.7% it’s a pretty disappointing and grim picture for those of us naively hoping all that money-printing talk would materialise into something better than this.

What’s more, it appears, the Fed is willing to print more ‘greenbacks’ if that’s what it takes to get America moving. Frankly, despite 30 years in the business, I just don’t get the whole quantitative easing bit. In fact I like the way KohnCougar’s fund manager, Jason Evans, describes it - “they are just kicking the can down the road”. How right he is. Nonetheless, no matter how good Jason’s common sense approach is, your investors are still left with a dilemma. What should they do with their retirement nest eggs, savings or investment funds?

So here are some strategies you might want to employ when trying to answer your clients’ questions about portfolio construction in these crazy times.

investment risk

Generally, where investments are concerned, there are a few basics you and your clients can use to find the right balance of investment risk for the prevailing economic circumstances. I’m not going to pretend this is a ‘euro-crisis panacea’, because who knows what European leaders and the central bank will do to tackle the continuing crisis. However, as a broad rule of thumb, these strategies should help you work out what to put where in very different economic conditions.

The first place to start is to think in terms of four economic conditions against which these ideas can be used and the five key asset classes that investors tend to place their capital. The five asset classes are cash, bonds, property, equities and commodities. These categories do not change throughout the four economic conditions under which you or your clients have to make decisions. They are: deflationary; price stability; moderate inflation and rapid inflation.

In deflationary times investors are generally better off placing greater emphasis on government and corporate bonds, cash and cash equivalents. Clients should still retain exposure to equities but are better advised to be underweight as share prices will, more likely than not, struggle under the strain of falling prices. Property is unlikely to grow against the backdrop of deflation and consequently a neutral weighting is likely to be appropriate and little or no exposure to commodities.

Emphasise equities

In an economic period referred to as price stability inflation is low. As such your clients would generally be well advised to give much greater emphasis to equities, whether in funds or directly held. Areas such as bonds, property and commodities are likely to be held but in a neutral manner. Gold and other such commodities along with cash should be avoided or reduced to modest levels.

Moderate inflation as the term suggests means the price of goods and services generally rise moderately. Against such a backdrop yours or your client portfolios should remain the same as above under price stability. However, an increased weighting to cash is advisable.

Finally, the fourth category is rapid inflation. At these times cash is a bit of a laggard and a neutral weighting is called for. Investors need to consider giving much greater emphasis to commodities and equities as they are likely to be the primary beneficiaries of such an economic backdrop. Property inevitably has its role to play, too, whether directly held or through funds. Bonds as the final asset class need a very modest holding.

risk averse

Much of these ideas are based on modern portfolio theory (MPT). MPT assumes that investors are risk averse, meaning that given two portfolios that offer the same expected return, investors will prefer the less risky one. Thus, an investor will take on increased risk only if compensated by higher expected returns. Conversely, an investor who wants higher expected returns must accept more risk. The exact trade-off will be the same for all investors, but different investors will evaluate the trade-off differently based on individual risk aversion characteristics. The implication is that a rational investor will not invest in a portfolio if a second portfolio exists with a more favourable risk-expected return profile - namely, if for that level of risk an alternative portfolio exists which has better expected returns.

In short, as much as we can all have a broad-brush strategy for tackling investment decisions in these difficult times most investors are different. As such tailor making the solutions to your clients’ objectives is by far and away the best policy.

And if it all feels like gibberish why not give us a call? We are happy to answer any of your investment dilemmas, irrespective of whether you are using our service or not!

• Roddy Kohn is manager at multi-award-winning KohnCougar. He can be contacted by email – roddy@kohncougar.co.uk

This article is taken from “Accounting Practice” the ICPA quarterly magazine. Dedicated to supporting and promoting the needs of the general practitioner. You can find us at  www.icpa.org.uk  or email info@icpa.org.uk  or by ‘phone on 0800-074-2896