It needs to be made clear that neither of the above is wrong; they are just different, as they are aligned to different levels of expected risk and return and based on different market assumptions.
So, obviously, in the same way as the ‘one and done’ funds, advisers should use the asset allocation models, or the volatility boundaries produced by their risk profiler of choice to create and manage their model portfolios.
I’d also suggest that the risk profiler should have a portfolio analysis tool that will check that the portfolios created by the adviser exhibit expected risk and return characteristics in line with the risk profiles, by looking inside the funds to ensure the fund assets are aligned to the fund name and objective.
For example, large amounts of cash within a fund, which may be a tactical decision on the part of the manager, may skew the risk characteristics of that fund.
A good portfolio analysis tool will take that into account and reflect that across the portfolio.
Obviously not all risk profilers provide this functionality and advisers should then consider using an additional stand-alone portfolio analysis tool to check the asset allocation and/or projected volatility levels of their portfolios, albeit at additional cost.
Once suitability for either a ‘one and done’ or ‘fund picking’ approach has be established there are some further aspects that the advisers could consider, when selecting the actual funds.
Purely as an example, at Defaqto we use the following, as part of our Diamond Ratings process, which looks to rate funds based upon where they sit in the market, considering both performance and a range of key attributes, including the following:
Criteria | Things to consider |
| Group AUM | Size of group AUM is an indicator of total resources available to the fund, such as research, risk management and compliance. |
| Fund size | Funds that are too small to be economic are likely to be closed, while funds that are too large will find their size impacts on investor returns due to liquidity and market impact issues. Critical fund sizes vary from sector to sector. |
| Manager tenure | Managers with greater experience of managing a fund are a likely indicator of achieving fund objectives in future. |
| Domicile | Funds registered within Great Britain will enable investors to access the Financial Services Compensation Scheme (FSCS) if necessary. |
| Ongoing charge | Lower costs will be less of a drag on performance. |
| Sharpe ratio | Better past risk adjusted performance might indicate better future risk adjusted returns (total risk). |
| Rolling Sharpe ratio | To measure the consistency of risk adjusted performance across multiple time-periods (total risk). |
| Calmar ratio | Better past risk adjusted performance might indicate better future risk adjusted returns (downside risk only). |
| Rolling Calmar ratio | To measure the consistency of risk adjusted performance across multiple time-periods (downside risk only). |
| Counter-party risk* | A counter-party with a high financial strength rating is more favourable than one with a lower financial strength rating. Using multiple counter-parties is better than one or two, as the risk is spread. |
| Capital Batting Average** | A fund that experiences a permanent fall in capital may find it more difficult to generate income in future. |
| Delivered Yield** | Funds that have delivered high yields to in the past may continue to do so in future. |
| Income Volatility** | Funds that deliver more consistent dividend distributions will be more useful for income investors. |
Choosing suitable investment solutions can be a complex business and creating a cohesive investment proposition can be a genuine challenge.
However, hopefully the above has provided some high-level thoughts on the subject.
Paul Tinkler is insight consultant for funds & DFM at Defaqto
