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Posted by on Oct 26, 2016 in ETF Strategist, Market Insight

Governments Are People Too

Governments Are People Too

By Roger Nusbaum, AdvisorShares ETF Strategist

It turns out the relationship between the Norwegian government and the Government Pension Fund of Norway (that country’s sovereign wealth fund) is a lot like an emotional client and his advisor. The government commissioned a report that is trying to pressure the fund to increase its equity allocation to 70% from 60%.

Here is the money quote from the Financial Review’s coverage;

“With a higher share of equities, the expected return will increase as will the income to the government budget. Yes, it comes with higher risk but we think we are well equipped to handle this risk,” Hilde Bjornland, an economics professor behind the recommendation, told the Financial Times.

This is a classic sign of the complacency that occurs after years of strong equity returns. It reads like they have forgotten what bear markets feel like which is something I have written about very specifically over the years believing it to be in an important, potential stumbling block for investors. The premise here is simple, the more you have in volatile assets, or potentially volatile assets, the more bad kind of volatility you are exposed to when the market declines. This exacerbates the decline, increases the emotional response creating an increased likelihood of succumbing to emotion.

Quite a few years ago our firm had a client (a married couple with strong but not huge assets) with a very low tolerance for equity volatility and so maintained a 20% allocation. Sure enough, after several years of bull market, the client wanted to increase to 50% in equities. I said this was a terrible idea and ultimately the client stayed at 20%. This was early in 2007. Every advisory has anecdotes like this. The point here is about choosing a suitable asset allocation and not making changes to it based on emotion. Had the client wanted to do this 18 months later, after the large decline, I would have been on board. This anecdote is identical to the Norway report.

Part of the equation in Norway is the realization that fixed income yields are not likely to return to what they perceive as being normal any time soon. The yield issue is something we have discussed many times in terms of the need to be more willing to use sectors like high yield and bank loans. There is a little yield to be had (albeit very little) in more traditional income market sectors. Obviously I am a big believer that bond market like returns and volatility is available in certain alternative strategies that I’ve written about dozens of times previously.

If a client was hell bent on increasing their equity exposure in the above context would suggest doing it very slowly, like over a period of a couple of years.

This story is a great example for advisors that even the biggest of investors, literally, have to deal with emotions and biases and you clients are counting on you to help them with theirs. For individuals, managing their own portfolios, being able to recognize your own vulnerabilities and biases should add value to your long term result.