Whether you are looking to manage monies for a first-time or seasoned investor, to have a good chance of achieving your clients’ goals, it is essential to have a robust and disciplined investment process. When it comes to portfolio management, there are a number of key rules which are employed to ensure that a portfolio is sensibly structured, that risk is controlled, and that costs are kept to a minimum to ensure the best possible risk-adjusted returns over the longer term. Gavin Haynes (who is pictured above), Managing Director at Whitechurch Securities in Bristol, outlines how he and his team approach these essential elements with seven golden rules as follows:
- Stringent risk management
The increasing importance of stringent risk management of clients’ investments has been a key reason why more and more advisers are outsourcing to a DFM in recent years. In order to be effective, it is important that, when managing a portfolio, we work within clearly defined parameters.
Of course, it is very important that clients understand the risks they are taking. Technical terms such as volatility and drawdown mean very little to most investors. When risk–rating portfolios, we use a starting point in terms of the maximum exposure a portfolio will have to equity-based, risk investments. For example: 4/10 will be 35% while a 5/10 rating would mean 60%. However, it is important that a wide range of risk measures are employed when managing a portfolio. Advisers should take time to understand the DFM’s risk processes and how they come to their conclusions.
- Meeting a client’s objective
However, it is not just about risk ratings; it is important to have an equally strong focus on the actual return objective of the underlying client. One size does not fit all. A portfolio with a risk profile of five which is looking to maximise growth should be very different from one where a client looks to maximise income. For example: an income portfolio is likely to have a materially higher bond content. This is where a tailored portfolio can provide more options than a simple model.
- Diversification
We will invest in a well-diversified portfolio of investments spread across different asset classes and different markets. Portfolios that concentrate on only a few investments are likely to give the wrong results and fail in their objectives. However, if the portfolio is using collectives, then a combination of around 20 funds should provide sufficient diversification for most investors’ needs. Portfolios with significantly more holdings show a lack of conviction and dilute the impact of the management team’s best ideas.
Diversification is not just about the number of underlying investments. Managers also need to understand how the different investments are likely to perform in different economic climates, so as to ensure that clients’ portfolio holdings are not going up and down in tandem.
- Asset allocation
Different asset classes offer diverse characteristics that, in turn, provide differing levels of risk and potential performance at different stages of the economic cycle. Even within asset classes, different areas have totally different characteristics (a short-dated high yield bond fund bears little relation to a long-dated Gilt fund!).
Active asset allocation doesn’t mean that a manager will be positioning a portfolio based on making big calls about what he or she predicts will happen in the future. You only have to see how bad institutions such as the Bank of England are at making projections (despite having access to the best sources of data) to understand that this is not a formula for success.
We take a pragmatic approach, and although we will position the portfolio based on our view of the investment backdrop, the process is not based on following a benchmark. We will insure the portfolio against our views being wrong. Our focus is on creating marginal gains (not taking big bets) and on ensuring consistency. This is key to meeting client expectations over the longer term.
- Fund selection
Once we have ascertained a suitable asset mix to both meet a client’s requirements and the prevailing economic environment, our fund selection process aims to look for best of breed funds across the whole market. We look at OEICs, investment trusts and ETFs to find the most suitable component for each working part of the portfolio.
The active versus passive debate will continue to rage, of course, but for us the starting point is to look for the lowest cost (passive) solution. If the client is going to be charged more than this, then we want a high degree of confidence that we will be receiving value for money. However, the fact that the majority of our portfolios are invested into active funds means that we do go for value rather than the cheapest possible solution!
- Stress testing
Once we have built a portfolio, we go through the very valuable process of stress testing. Using risk management software, we can undertake scenario analysis to gain an understanding of how a portfolio may perform in different climates (eg rising interest rates, stockmarket crash etc). This can highlight any potential holdings that may be exposing the portfolio to greater levels of risk or damaging the performance profile and arrange for us to make any necessary changes at the design stage.
- Day to day management
Ensuring the correct asset mix and fund selection against a constantly changing backdrop is the most complex and time consuming part of day to day investment management. Over time, things change a lot. Sectors, regions and fund managers that have performed well in the past can suddenly struggle or fall out of favour. It is important to review portfolios constantly to ensure that potential underperformers are removed and any recognised investment opportunities are introduced. Reviewing and rebalancing a portfolio quarterly is not active management! Although we are long-term investors and aim to minimise turnover, it is important to be prepared to change direction when the facts change if we are to achieve our goal of delivering the best possible results for clients on a consistent basis.
About Gavin Haynes
Gavin heads up the day to day management of Whitechurch’s Discretionary Fund Management services. With over 20 years industry experience, he has been managing multi-asset investment portfolios since 1997. Gavin is a leading commentator in the industry on fund research and asset allocation. He holds a Masters in International Economics, BA Hons degree in Financial Services, the Investment Management Certificate (IMC) and is a Chartered Member of the Chartered Institute of Securities & Investment (CISI).
