There are plenty of instances in financial services of ‘tails wagging dogs’ – of actions taken to accommodate poor decisions from the past. And it is probably because Defaqto risk-rates funds and portfolios that, as a business, we often have a bee in our bonnets over investment-naming conventions in relation to the portfolio ranges on offer.
If we look at MPS portfolios, these tend to be managed as part of a range, are usually managed by the same team, and each one will, broadly, have a different risk profile so that each portfolio will be suitable for a different client segment, according to their attitude to risk.
OK – so suppose we look at the MPS portfolios available through adviser platforms. What does this look like at first glance? Well, there are something like 1,860 portfolios that are part of a range – from almost 100 DFM firms.
There are perhaps a couple of hundred portfolios that are stand-alone – either specialist or in the main ‘token’ ethical or income portfolios – but the vast majority are part of a range of portfolios linked by risk and investment team. Data held within Defaqto Engage, the adviser research software used by around a third of advisers in the UK to help their clients make smarter financial decisions, shows there are 310 ranges, which on average translates to about six portfolios per range.
Most ranges of portfolios have been developed with different segments of clients in mind – and we would consider a ‘range’ to comprise a minimum of three portfolios. It is arguable what constitutes a reasonable number of portfolios to appeal to the widest number of clients and, more importantly, what number is likely to put off an adviser from selecting a particular range.
Time is money
Arguments we have had from DFMs with only three or four portfolios in their range point to the case that, if advisers feel their clients fall between two risk levels, they could look at blending two or more of the portfolios to achieve the desired outcome.
With adviser time being so precious, however, it does pose the question why they would want to force them to undertake even more work to identify the appropriate blended percentage weighting to achieve the desired outcome. DFMs could of course, reach out to rating providers to assist in these situations …
I struggle to understand why an adviser would select a range with this possibility in mind. There are, as we have noted, many other options available with a wider range of solutions. And it is to this last point that we have started to see a shift in adviser behaviour when compared to previous years – which is undoubtedly down to the greater flexibility and availability of ranges across a multitude of platforms.
Advisers are now expanding their CIPs to use individual portfolios from specific ranges, based on their own merits, to match specific segments of clients. This growing trend is probably a function of advisers becoming more familiar with the market, and data providers such as Defaqto having a greater breadth and depth of individual portfolio information, such as total costs, performance and greater transparency all round.
(Just to underline the strength of this trend, Defaqto has for a number of years been providing a quantitative appraisal of a proposition’s quality for the range of portfolios offered – known as a ‘Diamond Rating’ – to help advisers select a family of portfolios from a DFM to populate their CIPs. With the trend we have seen around advisers selecting individual portfolios from a range that most suits the risk profiles of their clients, we have recently launched single portfolio diamond ratings for MPS portfolios.)
So, where was I? There should be an expectation that a portfolio’s name gives a reasonable indication of where it sits in the market – either in terms of risk or investment style (active, passive, ethical and so on) or preferably both.
“Advisers are now expanding their CIPs to use individual portfolios from specific ranges, based on their own merits, to match specific segments of clients.
It may be tempting to think a 'portfolio 3' in a range of 5 would be balanced – probably in the middle of the risk/reward efficient frontier – yet this is not necessarily the case.”
Now, I acknowledge that informative nomenclature is difficult and predominantly those stating an investment style do adhere to that approach. In respect of risk, however, the picture can be somewhat different. Defaqto launched a series of five MPS Comparator indices last year and there was a significant amount of debate on what to call them. In the end it was decided the most obvious names would be the most informative – hence Defensive, Cautious, Balanced, Growth and Adventurous.
There are many portfolios that follow this naming convention, or similar, and often when there is a wider choice of portfolios there will be a ‘Balanced Plus’, ‘Growth Plus’ and so on. Aside from one person’s ‘Balanced’ being another person’s ‘Growth’, you do get an idea where the portfolio sits.
Numbers game
There are, however, around 800 portfolios that are simply numbered. It could be argued this gives an indication where on the risk scale they sit and certainly in relation to each other – yet advisers do need to be careful. Defaqto’s risk scale is 1 to 10 but there are others that are 1 to 7 and some that are 1 to 5 – and there are probably any number of variants.
It is likely that at the time of launch, portfolios were matched to one of the various scales but there are two things to be mindful of. First, glancing through these portfolios, even the numbering has variants – I have seen 1 to 10, 1 to 6, 3 to 8 and many others. As an example, it may be tempting to think a ‘portfolio 3’ in a range of 5 would be balanced – probably in the middle of the risk/reward efficient frontier – yet this is not necessarily the case. Some firms may not offer the option of lower-risk portfolios – or higher-risk portfolios for that matter. It is important to find out the risk spectrum of the portfolios.
Second – and perhaps a little more unnerving – is where portfolios have been matched to a firm’s risk rating at the time of launch but, over time and for any number of reasons, which might include a more aggressive stance from the fund manager, changes in market conditions, changes in strategy and so on, the portfolio has breached its appointed risk rating and needs to be moved to a higher or lower rating.
A change in rating is disruptive and makes advisers nervous – and of course investment managers, on the whole, do not like it. For instance, a portfolio numbered 5 and neatly risk rated 5 suddenly becoming a 6 does not look good – and, in many, instances portfolio managers are ‘encouraged’ to change their thinking and where they are investing to bring their portfolios back in line. Presumably they have made investment decisions for a good reason, so should they amend their thinking because of where they sit on a risk scale?
At Defaqto, our MPS Comparators have removed the external noise and deliberation around a proposition’s naming convention. All 1,900-odd platform MPS portfolios are continually assessed and appraised on their historic volatility so advisers can have confidence in selecting portfolios that demonstrate similar characteristics rather than assuming what a name or number within a range may potentially imply. And do not be surprised to find the occasional proposition sat in a Comparator cohort with a differing naming convention – a clear demonstration it has delivered a risk-adjusted return different to its title.
Andy Parsons is head of investment & protection at Defaqto
