Asset allocation is the buzz phrase among investment intermediaries these days, as the emphasis has shifted towards ensuring clients have a balanced portfolio to protect against capital and investment risk.
At present, the skill set requires intermediaries know the detailed specifics of every investment fund offered by a company, so they may select the most appropriate one to the client’s asset allocation needs – no small task given the 2000 funds available in the UK market.
However, one firm is predicting the future investment market will be dominated by specialist firms whose attention is targeted at only one sector of the market.
Niche investment house Blue Planet established itself in 1994 as a specialist investment trust manager which would create funds only investing the financial services sector, as this was the specialist knowledge its directors have, and now holds top quartile positions on all three investment trusts over three years.
The firm has now expanded its remit to include a global financials fund, and intends to open its range further.
But the key belief of its chief executive and cio Kenneth Murray is financial advisers will increasingly turn to specialist investment houses and their associated funds in order to protect the client against the risk of inadvertent overexposure to popular sectors. How realistic that prospect is has yet to proven, but Murray is convinced the shift will take place over the next 10 years.
A presentation by Morningstar’s managing director, Don Phillips, at the 2005 IFP conference, for example, highlighted the dilemma many investment intermediaries face: funds are selected to increase portfolio diversification, but many funds – even where they apparently follow different stock selection methods and criteria – can be found to expose the client to the same types of stocks and sectors, such as energy stocks because this is where many fund managers currently see the returns potential.
Phillips argued analysis of stocks held within each fund at that time found funds were overweight in energy and manufacturing stocks, so any downturn could affect several of a client’s investments, even where it is thought the portfolio is well-diversified, and much in the same way as they were affected by the tech stocks bubble.
It’s a focus which Fidelity has now also picked up on, as its research points out the UK stockmarket has seen activity concentrate on three key areas in the last 10 years – energy, banks and pharmaceuticals.
Whereas in 1996, less than a third (31%) of the UK market was concentrated in the three largest sectors, it peaked in 2002 when the top three sectors (energy, banks, pharmaceuticals) accounted for half of the market’s total value and today the same three sectors represent 47% of the MSCI UK index.
Fidelity’s aim here is to promote its new global special situations fund, by highlighting the fact global funds tend to be able to better diversify against sectoral allocation, as there is a wider range of stocks to choose from and their local economic exposure could also be very different to the UK, for example, as the MCSI World index shows with sector composition measured to be just 30% of the benchmark.
“The UK market has a strong bias towards three sectors – energy, banks and pharmaceuticals & biotechnology, “ says Jorma Korhonen, described as “manager designate” of the Fidelity global special situations fund.
“This means that portfolio performance will largely reflect what is happening in these areas. By taking investment further a field this reliance on particular sectors is diminished, as shown by our research into the world index.”
So is the way to counter exposure to one sector, through all apparently-diversified investments, to invest in specialist funds which focus only on one sector of the market as Murray suggests,?
Justin Modray, head of communications at Bestinvest, believes while IFAs are looking more at asset allocation, there is still some concern investors will prioritise and jump on performance returns ahead of risk diversification.
“It is important for IFAs to understand the asset allocation, such as how much a client has in equities and bonds versus other assets, and how much is in small companies, for example,” says Modray.
“But the worry is you can have very specialist funds, and people will only buy them because of the performance. People are now looking to buy commodities and commercial property because of the strong performance they have seen, when now might not be the right time to buy. What we find tends to happen is people rush in and buy blindly,” he adds.
There is some argument towards selecting investments based on an investment company’s sector specialisation, suggests Modray, for the very reason Phillips highlighted – in order to ensure asset allocation and fund selections are appropriate and clients are not overexposed to one particular sector of the investment market, IFAs have to keep one eye on where a fund is investing.
This, however, presents a potential new problem, suggests Modray, as advisers could find in order to justify investment in certain sectors recommendations, their focus might then need to shift from selecting appropriate funds for their client’s portfolio diversification needs to analysing the investment cycles of each sector and country and how fund managers are countering it, to ensure the funds they have recommended are not likely to be affected by a shift in sector focus.
This could essentially change the roles of IFAs, suggests Modray, away from serving clients to become economists and investment analysts.
“Should IFAs be calling cycles, rather than looking after clients and so forth?" says Modray.
"We would be better to leave that to a Frank Russell or a Cazenove who try to position the funds well by buying companies they think will do well. If you begin to select funds based on sector investment, the question has to be would you have an issue in certain cycles where you could get hit, and the client is hurt as a result? Global financials are less of an issue, for example, because the fund managers will try to manage a different stage of the cycle. But it could take IFAs away from their core duty of looking after clients if you were to select mainly based on sectors."
The concept of investing a client’s assets with fund managers who only have specialist sector knowledge seems an interesting idea, as it might help to limit a client’s exposure to sector consolidation and overexposure to markets which could suddenly turn.
But until there is clearer evidence of investment intermediaries changing their investment fund selection criteria and research, feedback suggests specialist managers may have longer to wait than they might hope for a change in IFA thinking.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Julie Henderson on 020 7968 4571 or email [email protected].IFAonline
Joined as head of strategy, multi asset, in June
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