In recent years there have been a number of complaints against advisers in which the Financial Ombudsman Service has ruled that the client’s risk appetite was not properly considered.
Some of these complaints were upheld even though it transpired that the client had withheld important information.
It is no wonder that advisers often err far too much on the side of caution for fear of being hauled up in front of the ombudsman.
As a result it is possible that clients with longer investment time horizons may be ending up with portfolios that are too low risk and thus likely to fall short with respect to investment objectives.
More worryingly, it is possible that they are over exposed to so-called safe haven assets such as government bonds which may be in fact be riskier than is generally believed.
Take UK government bonds for example.
Currently, the yield on the 30 year inflation protected Gilt is -0.846% which means that if you buy it today and hold it to maturity you will lose 22.5% of your real capital. In fact there is no risk of this not happening (excepting the British government defaulting). It is guaranteed.
Twenty years ago the yield was around 4% which meant you’d make 224% real. Do people really understand the extent of this change? I’m concerned that many don’t.
The US, with its long data history, provides a useful guide to the future.
Since 1849, US long bonds have produced a real return of 2.1% per annum.
However, there were two long periods (one of 19 years from 1901 to 1920 and the other of 41 years from 1940 to 1981) when real returns were substantially negative: -4.2% and -2.7% per annum respectively. A static, balanced portfolio approach during these periods would have been disastrous!
The reason for the poor performance was not that real yields were rising, though they may well have been. Rather, or mainly, it was because inflation was rising.