As investors become more savvy about their expectations from their portfolios, advisers and product providers are turning to more diverse offerings according to their clients' risk profiles
Hedge fund blow-ups such as LTCM and accounting scandals like Enron have highlighted one of the most important considerations when constructing an investment portfolio - assessing risk. Investors have become savvy about what they want from their investments and the returns they hope to make. Ensuring a portfolio is diversified according to a client's risk profile is one of the most important considerations when it comes to their construction.
Bill Blevins, managing director of intermediary group Blevins Frank International, says: "When we are approached by a high net-worth individual (HNWI) we give them detailed documents to fill out which gives us an understanding of their attitude to investment risk.
"We also look at a client's overall objectives, for example if they require income in the long, medium and short term. Most of our clients are retired expatriates and we look to see whether or not the assets are tax efficient as it is essential that they are not paying unnecessary tax."
At JP Morgan Private Bank, a four-step process is used to determine a client's investment objective for their portfolio. Craig Anderson, head of the bank's Advice Lab for EMEA, says: "Firstly, we look at where they want to go, what may stop them getting there and what return they would not like to drop below. We also look at their tax situation, what assets they are allowed to invest in and what restrictions they may have."
"Secondly, we work on the clients asset allocation and where it could go on the downside, then work with families to make the decision. Thirdly, we have a tactical overlay and tweak the asset allocation decisions depending on where we are in the economic cycle. Finally there is the implementation of the portfolio, taxation costs are considered and risks that could occur in the future are examined."
According to Anderson, one of the most important issues raised when constructing a portfolio are the liquidity requirements of the clients. This is what often drives the mix of asset classes and the risks associated with them so everyone can sleep at night. Clients are always made aware of the risks from the outset.
Similarly, the selection of funds for multi-manager products is also based on the idea of controlling risk and providing clients with diversity.
Antony John, managing director at IMS, chooses funds for multi-manager style products. He thinks clients are looking for more diversification in their portfolio to reduce risk and believes a fund of funds can deliver this. He chooses funds through a blend of qualitative and quantitative methods.
On the quantitative side, risk is assessed by John looking at data sourcing or what asset group the manager is in; discrete data or whether or not a manager is delivering consistency in performance over a five-year period; style bias whether it be value or growth, small, medium or large cap; fund manager turnover where the manager has left; and impact on the fund's performance.
On the qualitative side, the manager is interviewed along with the team of analysts, chief investment officer, chief executive officer to get an understanding of the culture of the company. Other factors considered include merger activity as this can have an impact on the company's culture. The qualitative judgement is the major determinant on what fund will be in the portfolio.
"A view is built up of the manager's performance consistency and how it will perform against all economic back drops and whether or not they can generate alpha. Other considerations that need to be addressed include looking at what part of the market you want to be in, for example is it large or small cap," says John.
If the economic or investment backdrop changes and a client's portfolio needs changing, Blevins thinks it is important to talk to the client first before any decisions are made. For example, the threat of political instability and terrorism could have a big impact on the market. Unless he is convinced there is going to be an imminent collapse in the market and the client cannot be contacted, a decision will not be made without their knowledge.
Blevins points out: "Clients study the performance of their portfolios and understand what they are investing in. They are made aware of the risks involved in putting money into equities and bonds that these may go down as well as up."
At Blevins Frank International, advice is always given on the cautious side as most clients will leave if their investment suddenly turns volatile and starts to under perform. Investment selection is risk graded, providing them with diversity of choice.
John sees the trends for risk profile driven by the runaway oil price as well as accounting scandals, leaving clients wanting more diversity. There have also been fund groups looking to launch more eclectic funds in unusual areas like minings and minerals.
According to Blevins, there has been a gradual change towards clients wanting to invest in the currency of the country they are living in. For example, his continental European clients do not want to invest in sterling.
Blevins also feels there has been huge demand in dollar investments as the US is the world's largest economy and the markets have done well. The dollar is also weaker than both the euro and sterling so if a client makes an investment in dollars and the currency goes up substantially, then they can make substantial gains.
Other opportunities that have emerged have been on advising clients on what they can do in regard to the EU Savings Tax Directive when it comes about.
"This directive has had a significant impact on our client base and they need to plan their tax accordingly. Clients can put their money into an insurance bond which is not reportable under the directive. Pension payments are also exempt. People need to make sure their tax is legitimate and need intermediary advice," says Blevins.
Two movements that Anderson has monitored is a trend for clients to want products to move away from the benchmark and wanting a mix of different managers and styles. For example, there has been an increase in people investing in hedge funds as well as other alternative investments, such as private equity.
Ensuring a portfolio is diversified according to a client's risk profile is one of the most important considerations for its construction.
If the economic or investment backdrop changes and a client's portfolio needs changing,it is important to talk to them first before making decisions.
There has been a gradual change towards clients wanting to invest in the currency of the country they are living in.
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