Observer: The quest for the Holy Grail of investment

Remind me to put accounting conferences at the bottom of my ‘to do’ list.

Recently, I made a presentation at a major accounting conference about ‘building smarter investment portfolios’.

Apparently the wealth accumulation stream was the most popular of the six different streams being offered and early on in the presentation I thought I was going reasonably well. However, as things progressed I noticed a glazed look on many faces in the audience, suggesting most had no idea what I was talking about.

At the end of the presentation there were no questions from the audience and no one approached me to expand on anything I had covered. This was in marked contrast to a recent presentation to delegates at a Financial Planning Association conference on the same topic, which had generated considerable interest.

Of course, it could well be the case that I simply delivered a poor presentation and failed to get the key messages across. Perhaps, but what was most alarming was not the (lack of) reaction to my own presentation but rather the very different reaction to the previous speaker.

While masquerading as a talk on investments and wealth creation strategies, it was basically a thinly veiled promotion of residential property investment and the presenter’s books on the subject. It was put together and presented well enough, but the concepts hardly went beyond Investments 101 and were the usual (wrong or distorted) industry mantras — property and shares always outperform over the long-term, spread money in the four main asset classes and so on. Nevertheless, the audience seemed to love it.

However, it was when the presenter moved on to residential property that the audience really began salivating. It was all so easy, we learned. All you have to do is buy properties in the lower price range where the net rental yield is above the cost of finance. You don’t even have to see the properties.

The presenter acknowledged that such positive cash flow properties basically don’t exist in the major capital cities anymore and that one needed to buy in smaller cities and towns to meet this criteria.

Having bought such properties, the idea was ‘never to sell’, which probably makes sense since some of the property the presenter was suggesting buying will probably be very difficult to sell in anything other than the speculative housing bubble we are now in.

The presenter was inundated with questions at the end and following the presentation, a throng of at least 20 people crowded around to ask for more. The adoring crowd was so persistent that after 10 minutes the conference organisers had to usher them out the door to make way for my presentation. My depressing conclusion — the property bubble is alive and well and being facilitated and promoted by accountants.

A recent survey suggests that something like 870,000 people intend to invest in property in the next year. I would suggest many are doing this with advice or assistance from accountants.

In hindsight, yesterday’s property investors look like heroes but investment today is about foresight despite the uncertainty and subjectivity that this entails.

However, it doesn’t take a lot of foresight to see that investing for the long-term in most residential property in the midst of the biggest property market bubble in our generation hardly seems a sensible strategy.

In fact, I believe that the unwinding of the property and household debt bubble will be the big financial story of this decade. Accountants should be prepared to share in some of the blame for the financial carnage that will inevitably accompany this.

When will the property market bust? I don’t know — a bubble is by definition heavily driven by irrational behaviour, and predicting when such behaviour will cease is near impossible.

How bad will it be when it busts? Again I don’t know, but the history of bubbles is that the busts are usually much larger than even the pessimists expect. Could the 50, 60 or even 70 per cent falls in residential property that have engulfed some Asian countries in the 1990s happen here? Why not? It would only take a rise in required net rental yields from 3 to 6 per cent (due either to higher interest rates or simply perception of higher risk and no rental growth) to halve prices.

While many financial planners are betting their clients’ future on the hope that equities always outperform other assets, many investors and their accountants seem to be betting their future on the hope that residential property always rises. Unfortunately, there are no guarantees and, as with any asset, the higher price you pay (relative to income generated), the less likely this future outperformance is. In any case, portfolios don’t have to be so one-dimensional.

No doubt my comments here will cause offence to those accountants who know their stuff and who may well be giving high quality investment advice to clients. My comments are meant to be very general and I know they do not apply to all accountants or accountants practising financial planning.

However, the problem is the poor current image of the financial planning community (some of it well deserved) is forcing more investors back to accountants and bank managers as their main source of investment advice and assistance. I suspect that on average, those investors are unlikely to be well served.

In fact, my experience with accountants has actually given me a greater respect for financial planners. Many advisers I talk to at least recognise the difficulties in constructing sound investment portfolios for clients, the flaws in modern portfolio theory and the need to achieve true portfolio diversification.

While I believe the industry has a long way to go in the debate over different ways to construct investment portfolios, at least discussion is occurring. Many accountants seem to be still in the dark ages when it comes to investments, with property investment the current Holy Grail.

The experience brought to mind the comments of former US Treasury Secretary Paul O’Neill who was quoted after being forced to resign from his position as saying: “It’s all about sound bites, deluding the people, pandering to the lowest common denominator, I didn’t adjust (in Washington) and I’m not going to start now.”

It’s easy to understand how he feels. While O’Neill was talking about politics, it could just as easily apply in the world of investments. Everyone wants to believe it is easy, to be able to describe their investment approach in a few words, to stick to what has worked in the past and to disregard new ideas and approaches.

Fortunately, not all the investment industry is like this.

There is a minority who can see the world as it really is, do not continually get caught up in the latest investment fad and are willing to look at more innovative and sensible approaches to investment.

Unfortunately, at least in my limited experience, the accountant community does not seem heavily populated with such people. Perhaps I should be the one to change to suit them. But then again, no. To paraphrase Paul O’Neill, “I didn’t adjust (to accountants) and I’m not going to start now”.

Dominic McCormick is chief investment officer withSelect Asset Management .