Diversification Q for IFAs

holly_hobby

Having a debate in the office, so I thought I know where the oracles are Duns. are you listening !

When constructing a balanced (in risk not ATR) and diversified portfolio, as a % of total vehicles already held and those being recommended, how would you split their overall portfolio between low, med and speculative vehicles for each type of investor ie cautious, balanced and adventerous .... not an exact science I know, but just something we were discussing today, and the fact the discussions of balanced portfolios was that it should have a mixture of all 3 to varying degrees, in relation to the clients ATR, to achieve true diversification .....

Interested for the thoughts and comments of IFAs involved in investment business .... not bothered if its for growth or income, its just for fun, and of course differing peeps will have differing approaches, but I'm looking for what possibly the common or most used split and approach you guys and gals generally apply.

Thanks guys

H xx

dunstonh

When constructing a balanced (in risk not ATR) and diversified portfolio, as a % of total vehicles already held and those being recommended, how would you split their overall portfolio between low, med and speculative vehicles for each type of investor ie cautious, balanced and adventerous .... not an exact science I know, but just something we were discussing today, and the fact the discussions of balanced portfolios was that it should have a mixture of all 3 to varying degrees, in relation to the clients ATR, to achieve true diversification ....

For bespoke portfolios, I use third party data purchased. The actuaries supply the asset allocations across each of the sectors based on a volatility rating. The percentages in each vary across 10 volatility risk scales. Individually, some funds would be above the risk profile whilst some would be below with the allocations across them all averaging out to fall within a volatility band.

When using multi-asset funds I would not mix funds from above and below as by their very nature, they are multi-asset and will have higher and lower risk assets within the fund. However, if there are existing investments where you are taking into account legacy assets you cant or dont want to move or you have multiple contracts, then I may use a bit in different areas to offset those.

I may use multiple investment strategies with multi-asset funds. e.g. part managed, part tracker or flexible.

holly_hobby

Thanks Duns .... so the allocation between fund types and providers, is sort of automatically split via an actuarial programme, and not as simple as the IFA, say for someone whom is cautious, looking at their portfolio and say having a split along the lines of say 70/20/10 (just as a crude example) etc, for argument sake ?

As that was the lines of discussion being held between various peeps

H

gadgetmind

dunstonh wrote: »

For bespoke portfolios, I use third party data purchased. The actuaries supply the asset allocations across each of the sectors based on a volatility rating.

With all due respect, this smacks of middle men upon middle men upon middle men. I prefer to get up close and personal with the underlying investments as it reduces fees and gives better long term results.

Yes, asset allocation is important, but that's not exactly rocket science, and thoroughly decent chaps in pinstripes don't come cheap, so it's best that we keep those to a minimum.

dunstonh

so the allocation between fund types and providers, is sort of automatically split via an actuarial programme, and not as simple as the IFA, say for someone whom is cautious, looking at their portfolio and say having a split along the lines of say 70/20/10 (just as a crude example) etc, for argument sake ?

70/20/10 is long in the tooth now. With increased due diligence requirements and the FSAs thematic review of risk profiling and the FOS position on risk and allocations, it is very difficult to really see how 70/20/10 could fit.

The actuaries provide the allocations for the sectors with a volatility score. Fund data is processed to provide fund volatility ratings. Then software puts the two together to make sure what you recommend stays within the risk profile recommended for that individual. You can break sector allocations (sometimes you have to as a legacy contract may not have a global bonds fund or a property fund or there may not be a fund that passes due diligence for a sector). However, in those cases the allocations are amended to reflect that to ensure the overall portfolio stays within band.

With all due respect, this smacks of middle men upon middle men upon middle men. I prefer to get up close and personal with the underlying investments as it reduces fees and gives better long term results.

So either you are spending the hours doing your own research or taking random punts. You have no liability for the actions you take as it is your own fault if you make a pigs ear of it. You also have no regulator paying you visits asking to see the due diligence you have taken and the reasoning behind your investment allocations. You may do a good job or you may not. It doesn't matter one bit as you are going DIY. You are not paying for it and you are not getting it.

If someone is using a professional then it has to be based on more than guessing up random numbers. There has to be a structure and process. And nowadays, you not only have to show the outcome but the processes and structures in place that got you to that outcome. The FOS would not accept a response from an IFA that they recommended an investment on gut feeling because gadgetmind on the MSE forums thinks that research and analysis is a waste of time and money.

This is not another thread about DIY vs IFA. We have had enough threads taken off subject by that and the same thing keeps being said. If you can DIY then DIY. If you cant then use an IFA. Just as you would in any other area whether it be accounts, building, decorating, maintenance etc.

gadgetmind

dunstonh wrote: »

So either you are spending the hours doing your own research or taking random punts.

There is a lot of clear blue water between those two extremes.

This is not another thread about DIY vs IFA.

OK, let's keep it about IFAs. People go to IFAs expecting advice on where to invest. Instead they get asked questions that they don't understand the implications of and from this a 3rd party pops out a potted asset allocation. This asset allocation usually gets met using actively managed funds (often funds of funds) with all the fees this entails.

Yes, there is structure, yes there is process, but people expect more given what they are paying. Maybe it's an expectation issue rather than a quality of service issue?

If someone is using a professional then it has to be based on more than guessing up random numbers.

So, there is the mythical efficient frontier, and there's random numbers, but nothing in between?

Sorry, but in my opinion professional asset allocation suffers heavily from "garbage in, garbage out" coupled to an unwarranted air of pseudo-scientific mystique.

BTW, I do accept that regulators and industry practice pretty much demand that IFAs work this way!

dunstonh

OK, let's keep it about IFAs. People go to IFAs expecting advice on where to invest. Instead they get asked questions that they don't understand the implications of and from this a 3rd party pops out a potted asset allocation. This asset allocation usually gets met using actively managed funds (often funds of funds) with all the fees this entails.

How is the IFA meant to advise the person if they dont ask questions to find out about the person?

What makes you think the method is not understood or explained?
What makes you think the fund of funds or similar are usually used?

I will say that I do often use multi-asset funds. There is no point building a bespoke portfolio for a small investor. It is not cost effective for them. There is also absolutely no harm in using multi-asset funds. Also, with MiFID, the recommendation has to be within the understanding of the individual. If the person shows little interest in investing or doesnt understand it then a simple option should be used. Often you do have to recommend things that you would not use yourself or with a more knowledgeable investor. However, simple does not mean wrong. It does not mean bad. It can actually yield better results sometimes.

The vast majority of investment complaints, of which there are not actually that many nowadays, come from people either not understanding investing or investing above their risk profile. The DIY sector is very prone to that as well. Indeed, I would hazard a guess that it is more prone to it.

Yes, there is structure, yes there is process, but people expect more given what they are paying. Maybe it's an expectation issue rather than a quality of service issue?

This seems to be at odds with what you said earlier. If the adviser does nothing and takes a punt it is wrong. If the adviser does the due diligence and research and uses a structure they do wrong. So, what are they meant to do?

So, there is the mythical efficient frontier, and there's random numbers, but nothing in between?

Tell us what the in between is then?

holly_hobby

Thanks Duns., this is the debate we were having.

So, there isn't a set process/division of funds between asset classes, that the IFA will follow themselves.

The modern adviser will instead utilise proprietary software as discussed, and as long as their suitability report provides clear and detailed info on how and where their client asset allocation, class and division has derived from, and the software programme used to come up with the recommendations etc (inc supporting prints), that will wholly meet and satisfy FCA requirements and any audit?

Many thanks Duns for the time taken in giving your comment and insight as to the steps taken by you (and no doubt other IFAs), to construct your portfolios.

This is my last question .... honest !

Thanks again buddy
H xxx

dunstonh

The modern adviser will instead utilise proprietary software as discussed, and as long as their suitability report provides clear and detailed info on how and where their client asset allocation, class and division has derived from, and the software programme used to come up with the recommendations etc (inc supporting prints), that will wholly meet and satisfy FCA requirements and any audit?

FCA requirements are open to interpretation as you know. So, you will always get opinions. Our compliance support felt that provider supplied risk profiling and portfolio builders should no longer be used. They believed that some steered towards solutions they offered whilst others didnt provide enough background detail on how they obtained and operated their models. Ultimately, what ever model or option you use, it is the adviser that carries the can. So, you have to carry out some due diligence on the asset allocation tool and risk profiler. Whilst the adviser "buys" the data and research for the allocations, the adviser still has to pick the funds. Each and every one of those needs a decent audit trail of research nowadays. Every fund has a different level of volatility and as it is not an exact science, there will be interpretations of the data that differ with different people. So, you have to make sure the fund selection does not break the volatility level for that risk profile.

A small IFA firm does not have the resources to do the due diligence in house. You have to get it in from outside sources but you have to make sure the outside source is good enough.

On my reports, I have a paragraph that mentions the actuary used and the method. Not overkill as the current trend seems to be to reduce the length of reports. I have documents available to issue to those that want to read more and a research file on how it gets there in detail which can be shown to the regulator or provided to the FOS if required. Reports are trending back to being summary at the moment with the client file containing the evidence to support the advice. So, less is going on the report about how you got there which is fine as long as you have that information on file and can show how you got there.

The move to cutting size down has come about as we were told that the FOS take a dislike to long reports and will often get to a certain page and decide that anything that comes after that will not be read by the client and will disregard that content. I have no personal experience of the FOS thankfully but I do read the publications and the recently published ombudsman decisions and the various meetings you go to that often have ex FOS staff to give guidance.

holly_hobby

Thanks for that Duns.

Yes, I agree that the FOS publications such as "ombudsman news" , and now the Ombudsman decisions database, are both v useful in considering a FOS viewpoint, either from an advice position or compliance/investigation/audit review - and they're generally a good read to keep up to date with stance changes etc.

Anyhoo, you've been extremely helpful and you know, I as always, appreciate your time and thoughts

Thanks again

Holly xxxx

Imnoexpert_2

Leaving aside the spat with Gadgetmind this has been very interesting.

My IFA who is an employee of a national group who specialise in an occupational sector used to be able to suggest funds and portfolios but now the result of our annual conversation is to indicate one of 5 portfolios which match a risk profile and which are chosen by head office. The fund choices are quite often surprising so it is reassuring to find there is some method to it. My IFA either doesn't know or isn't giving me the detail which DunstonH has available for his customers

A couple of comments though.

Risk profiles are very blunt tools (at the client side) - How scientific are the questions? - has there been psychological research on them? In my case a few years ago I would have answered the question 'How would you feel about the value of your funds dropping by 25%''? differently from how I would now. I don't think my attitude to risk has changed but my knowledge of and cynicism about financial services certainly has.

Is investing a science or an art? All the figures which measure risk and reward are based on historical evidence - and at the bottom of all of them is the statement that "the past is no guide to the future". It's better than nothing but surely it should only be a part of portfolio building. Is the 'science' playing too big a part?