‘Conservative’ model portfolios from UK financial advisers appear to have higher risk profiles than clients might expect, according to the latest UK Advisers Portfolio Barometer from Natixis.
The report analysed 70 model risk-rated portfolios from UK financial advisory and wealth management firms over the last three months to the end of September 2017.
The research found that, while the ‘conservative’ models are indeed more susceptible to losses in a significant risk event than clients anticipate, it is also the case for ‘moderate’ and ‘aggressive’ portfolios.
“In prior barometers we have frequently mentioned that over the past few years ‘conservative’ portfolios have been shifting their fixed income exposure to more diversified exposures such as alternative strategies, mainly in the targeted absolute return category and real assets such as direct property,” the team at Natixis said. “This is due to falling yields in traditional fixed income, and the long-expected reversal in the 30-plus year downward secular trend in interest rates.”
Upon first inspection, the report said the average ‘conservative’ portfolio is well-diversified across asset classes. Over the last financial quarter, the average allocation within ‘conservative’ models was 38 per cent to fixed income, 21 per cent to equities, 18 per cent to alternatives, 7 per cent to real assets and 10 per cent in cash.
Source: Natixis Portfolio Clarity
However, the team at Natixis created proxy model portfolios across the three risk levels using the average allocations to gain a further understanding of just how much risk each portfolio was undertaking.
It found that, in terms of the ‘conservative’ model, the equity portion represents 58 per cent of total risk for an allocation of just 21 per cent. In the event of a significant market downturn, the team warned it could therefore fall more than 10 per cent, which may mean it is better suited for investors with higher risk appetites.
Natixis also used a factor-based model to determine risk over rolling three-year periods since October 2004. It found that perceived risk levels seem to have fallen over the last three years, which therefore underestimates potential losses during significant market events such as the 2008 financial crisis.
“It appears to be underestimated by just over half – and is similar to levels seen just before the crisis,” the team said. “We are not suggesting a repeat of that crisis but we subscribe to the adage that history doesn’t repeat itself but it often rhymes. And as we see the scaling back of economic stimulus policies in developed markets this may be a time to review your portfolio risk.”
“The question to ask is: are advisers ready for a significant risk event?”
While the team found that ‘conservative’ models are more balanced than ‘moderate’ or ‘aggressive’ models in terms of risk and diversification, it warned that the potential for losses may catch some clients by surprise.
“The migration of advisers away from fixed income has been a benefit to diversification,” Natixis concluded. “However, in a significant market event, losses may be in excess of 10 per cent and clients in these portfolios may not be aware, ready or willing to assume this risk.”
Given this is indeed the case across average UK adviser model portfolios, FE Trustnet decided to take a closer look at investment vehicles within the IA Volatility Managed sector which are also operated on a risk-targeted basis.
The market area is home to a wide range of funds with differing volatility parameters and, as such, it can be challenging to determine whether its constituents are achieving their investment aims.
For very conservative investors with a keen focus on protecting on the downside, we filtered through to the funds in the sector in at least the top 25 per cent for their maximum drawdown (which measures the most money lost if bought and sold at the worst possible times), number of negative monthly periods, downside risk (which predicts susceptibility to losing money during falling markets), and annualised volatility over the last five years.
We were left with a total of five funds, as shown in the below table.
Source: FE Analytics
Of these, the fund which also boasts the highest five-year Sharpe ratio (which measures risk-adjusted returns) is Bambos Hambi’s Standard Life Investments MyFolio Managed II fund, which aims to provide a combination of income and growth through a range of Aberdeen Standard Life funds and collective investment schemes.
The largest holdings within the £1.7bn fund include Standard Life Investments (SLI) Global Absolute Return Strategies (or GARS) at 10 per cent, SLI European Equity Income at 5.6 per cent and SLI Global Corporate Bond at 5.5 per cent.
Over five years, it has returned 34.8 per cent and has done so with an annualised volatility of 4.11 per cent, a maximum drawdown of 4.15 per cent, a downside risk of 4.23 and a total of 17 negative monthly periods.
The research team at Square Mile, which has awarded the fund a ‘Recommended’ rating, said the fact that the fund can only invest in Aberdeen Standard Life vehicles could hinder its flexibility but will keep down costs which drag on returns.
“Over the longer term and given the breadth of talent and range of strategies from within the group which the team has to select from we believe the fund can deliver an outcome for clients which should meet their expectations,” it said.
A further three of Hambi’s MyFolio funds have made it onto our list: SLI MyFolio Multi Manager I, SLI MyFolio Multi Manager II and SLI MyFolio Managed Income II.
The former two, which are of course part of the same sub-range, are able to invest in funds that aren’t managed by Aberdeen Standard Life. The former’s largest holdings are Fidelity UK Corporate Bond at 8.8 per cent, TwentyFour Corporate Bond at 7.8 per cent and T. Rowe Price Dynamic Global Bond at 7 per cent. It also has an 8.3 per cent cash weighting.
The latter holds the Fidelity and TwentyFour funds as its first and third-largest holdings respectively, although it has Royal London Global Index Linked in second place.
Performance of funds over 5yrs
Source: FE Analytics
SLI MyFolio Multi Manager II has won a place on the FE Research team’s FE Invest Approved list which explained that, although the fund’s management team invests in other vehicles, it insists on those managers sending all of the information necessary to carry out detailed analysis of individual stocks and bonds.
“This way it can detect any bias or unwanted exposures,” it said. “Funds are re-balanced daily to take into account cashflows and market movements, and make sure the funds stay within their risk range.
“There is also an independent risk team that formally reviews the performance and risk objectives of the funds.”
Hambi’s third fund on our list, Standard Life Investments MyFolio Managed Income II, invests only in Aberdeen Standard Life vehicles and has more of a focus on income.
Had an investor placed £10,000 into the fund five years ago, they would have received £1,326.73 in income alone. In total return terms, they would have made 31.44 per cent with an annualised volatility of 4.23 per cent, a maximum drawdown of 4.26 per cent, a downside risk ratio of 4.51 and 17 negative monthly periods.
The final fund to have made our list is Aviva Investors Multi Asset I, which has been headed up by Thomas Wells and Paul Parascandalo since November 2015.
It aims to provide a combination of growth and income through a highly diversified portfolio of shares, bonds, deposits, cash, property and commodities. In terms of asset class weightings, it currently holds 17.8 per cent in global equities, 53.5 per cent in bonds, 19.4 per cent in alternative assets and 9.3 per cent in cash.
Over five years, the £147m fund has returned 20.3 per cent and has done so with a maximum drawdown of 4.03 per cent, an annualised volatility of 3.28 per cent, a downside risk ratio of 3.67 per cent and a total of 16 negative monthly periods.