Rebecca Jones looks at the changing face of portfolio construction, discovering a rising trend for simplification and strict asset allocation.
Putting together an investment portfolio for a client has never, in most cases, been an easy task. However, a combination of regulatory and market changes attributable to the financial crisis of 2007-2008 means advisers now face even tougher challenges when constructing client portfolios.
While as recently as just a few years ago an adviser merely had to decide between a portfolio of equities (high risk) or bonds (low risk), regulation now demands in-depth risk profiling of each client and a far more complex split of assets depending on risk tolerance, capacity for loss and financial sophistication.
Added to this are the complications brought about by the end of the long-standing bull market in bonds, which is leaving many traditional ‘low risk’ investors vulnerable to potentially significant capital losses when and if interest rates do finally rise.
'Investment advice is now three steps': The evolution of portfolio construction
The rise of risk
According to Paul Resnik, co-founder and director of risk profiling firm Finametrica, these pressures are resulting in advisers building simpler model portfolios than in previous years.
“Investment advice has evolved into three steps: an adviser needs to understand the investment, be able to explain the risks of that investment to the client and, finally, prove they have got the client’s informed consent. You cannot do any of that unless it is explicable, straightforward and predictable,” he says.
Fear of the regulator combined with the prevalence of risk profiling tools is playing an integral role in this simplification as advisers are increasingly building portfolios tailored to a risk ‘score’ that dictates prescriptive and often restrictive asset allocations.
However, in many cases, this is becoming a troubling method as traditionally low risk assets such as gilts have become high risk, leaving some advisers using these models at a loss as to where to put their lower risk clients.
This is principally why Justin Urquhart Stewart, founder of 7IM, is so dismayed at the current trend for simplified, prescribed model portfolios.
“The problem is that some of these stochastic models do not have flexibility in them; they just work on dogma, dictating that you have got to have X percentages in X assets. While that will allow you to obey the rules as far as some compliance officer is concerned, it will mean that your client is losing out and that is wholly inappropriate,” he claims.
Outsourcing the problem
For many advisers, the problems presented by modern day portfolio construction make outsourcing the only viable option. John Cushine, director of Carden Associates, has been outsourcing his investment decisions to discretionary managers since late 2011, which he claims has saved him both time and worry.
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