X-Rays reveal the cracks in model portfolios
van Eyk’s new initiative for financial advisers, Portfolio X-Rays, is revealing that many model portfolios are not set up to meet their performance objectives and are vulnerable to shocks and hidden risks.
Portfolio X-Rays are a consulting service introduced by van Eyk in October 2012. The service, designed specifically for advisers, forensically examines a model portfolio to see whether the investment outlook, risk tolerance and the model’s objectives are accurately reflected in how it is constructed.
The service dissects the portfolio by categories including asset class, investment style and fund manager selection to determine whether the design of the portfolio and the choice of assets is in tune with the adviser’s broader strategy for the retail investor and whether it is particularly vulnerable to certain threats.
It also uses current valuations and other proprietary information to determine the probability that a portfolio will meet its return objectives.
van Eyk Head of Asset Consulting Jonathan Ramsay said the X-Rays completed so far showed some of the issues were surprisingly common across portfolios.
“The results show that most portfolios require at least some adjustments and that it’s possible to reduce the level of risk without giving up performance or radically changing asset allocation,” Mr Ramsay said.
Some of the most common problems with model portfolios were:
- Many were overly vulnerable to profound or sudden markets shifts, such as an end to the rally in bond markets or a breakout in inflation.
- Combining too many active fund managers in a portfolio or doing so without due care can result in expensive, index-like returns.
- Some portfolios had an unintended bias to particular market sectors or a certain investment style.
“There was also a significant issue with alternative investments,” Mr Ramsay said.
“Although we are firm believers in using alternatives to reduce volatility and manage risks, some assets considered to be in the alternatives sector don’t offer the diversification and low correlation to traditional assets that investors want.”
Mr Ramsay said strong risk management was always desirable in investing, but especially now because of the large economic and financial imbalances left in the wake of the GFC.