A financial Advisor has the responsibility of assisting clients in selecting investment portfolios for their various investment requirements; this is the responsibility to select the appropriate asset allocation for you based on targeted risk, returns and time horizon objectives and generally comes in the form of having to choose the right unit trust for your investment.
I often come across clients’ portfolios whose solution is to hold multiple balanced funds as the underlying unit trusts, which I believe is an attempt by the advisor to ‘diversify’ the portfolio –this, in my opinion, is a quasi-approach to attempting to reduce risk and does not always work as the advisor intends.
One of the biggest contributors to risk is the asset allocation of the portfolio (i.e. placing more money into volatiles assets if the time horizon is short); blending balanced fund managers may exacerbate this risk instead of reducing it. The reason for this is the discretion that the various managers may have to re-balance the underlying weightings towards various asset classes, let’s explore this idea further.
Managers may, at various points through an investment or economic cycle, increase or decrease their holdings in, let’s say equity or bonds. This is alright if, on average, the fund manager’s combined in your portfolio hold opposite views on the market or hold different mandates as their changes in weightings will hopefully offset each other, by one manager increasing equity and the other decreasing the equity (or any of the other asset classes). The problem arises when the managers hold the same convictions to the asset classes and move in conjunction with each other (which is very common as most managers in a specific investment “space” may track the same benchmark or fall into the same peer group for ratings).
Your portfolio may now be more aggressive or conservative than when you originally set the account up, which may not be ideal to your required solution – said otherwise, this means that you cannot control your asset allocation. Everyone understands the analogy “buy low and sell high), and without a structured asset allocation you lose this opportunity in a structured and emotional way. If you initially allocate / invest 40% of your portfolio to the stock market (equity) and the stock market performs well then your allocation may, hypothetically, increase to 45%. You then should “trim” down this portfolio drift back to 40% and take the profit; this has the effect of keeping your account’s risk and return objectives in check. You also get some benefit if your stock market allocation falls, hypothetically, to 30% as you will then sell from the other assets classes to put more money into stocks, which you will now be buying at a cheaper price.
This is very complicated but my three simple recommendations to overcome the problem of not being able to control your portfolio asset allocation would be to:
- select balanced fund managers with verifiable differing views,
- hold a single unit trust and completely outsource the asset allocation decision to that single manager (this essentially means you are voting that this manager has the best team for every asset class, which is highly unlikely – so be careful with this approach), or
- to have your advisor creates a bespoke solution with single asset class managers and to have a solution “built up” for you.
You should approach your financial advisor’s recommendations with the “why, why, why?” tactic until you are satisfied with the reasoning that your financial advisor provides behind their recommendation. Remember that an advisor is only as good as their support, and without the appropriate software to assist the advisor, keeping track of your account manually may mean that your account gets neglected, especially if your advisor has a large number of clients.
There is evidence for both blending balanced funds (split funding) or using building blocks to tailor your specific asset allocation, the trick however does not lie in which is better but which is best for your strategy.
Robert Starkey RFP, MIFM