Which portfolio type might best meet client objectives?

15 May 2020

Achieving a portfolio that both participates on the upside and protects on the downside, is more likely to meet client goals than chasing top quartile returns or being overly cautious, suggests John Bellamy, head of Managed Portfolio Service, Waverton Investment Management.

As difficult as this period has been for advisers, paraplanners, asset managers and clients, we must keep all things in perspective. All around us are frontline key workers doing far more important, valuable and dangerous jobs and for that we thank them.

Having said that, as paraplanners the recent setback has provided the perfect opportunity to review your preferred investment solutions (and those on the bench) with the benefit of a full investment cycle behind you. Whatever volatility awaits in the coming months and beyond, you can now judge your providers through one of history’s longest bull markets and, most recently, through a surprising, savage and swift bear market. It is important that advisers are armed with this information so that they can communicate effectively with their clients in terms of how the selected portfolios have performed, whether any changes are to be recommended and the reasons for those changes.

We are hearing of most active managers falling in to one of two particular camps. The hares or the tortoises.

In the protracted period of steady, if unspectacular, economic growth and consistently rising markets it was all too easy to be charmed by the top-quartile returns of investment services coupled with the promise of active management and downside consideration. The problem being that whilst stellar historic returns are easy to demonstrate the protections within are not. There are too many stories now of clients in all mandates receiving 10%, or even 20% drop letters which goes to prove that there is more to active management than glossy slides and riding the risk train.

Equally, there are well known investment houses that are rightly lauded for their caution. Positive returns in the last great sell-off in 2008 and outperformance in Q1 2020 speak to investment processes that really are doing something very different. However, if these same processes were delivering little or none of the upside in the intervening years then surely they are guilty of reckless conservatism.

Maybe neither the tortoise nor the hare won this race?

There is a middle ground. It starts with a clear understanding from all parties (investment manager, adviser and client) of what the client’s objectives are, followed by a clearly articulated process to deliver these objectives within appropriate risk parameters. The challenge for the investment manager is to meet these objectives in such a way as to participate reasonably in rising markets and also protect from the worst of the ravages of the downside.

This challenge can be met with a broadly diversified portfolio that gives exposure beyond the traditional asset classes of bonds, equities and cash. It requires the managers to make full use of these tools and the discretionary permissions that they have been trusted with. So when the process is reviewed there is clear evidence of active (proactive not reactive) management through the last full cycle. There should also be good examples of how the portfolio construction dampened down the volatility of returns without minimising the gains in positive markets.

We find that such portfolios are best constructed from direct holdings (equities and bonds) rather than through a fund of funds approach. This allows for more control of the portfolio and a multitude of risk levers to pull through the cycle. Within such portfolios there is no reliance on third party managers to make the right calls at the right time.

Using this approach allowed us to enter the crisis underweight risk assets. We did not see the crisis coming, but we did see an equity market that was looking fully valued and an economic outlook that was challenged. With this in mind, over the course of the preceding 12-18 months we gradually reduced equities and corporate bonds in favour of lower risk sovereign debt and alternatives. At the same time our long-term strategic hedges were increased.

For portfolios managed on third party platforms it is not straightforward to deliver the necessary diversification, in particular the hedging instruments. The fact is that most managers are reliant on the limited funds that are available and these are not always there across all platforms. Whist past performance cannot be guaranteed, at Waverton, we find that our portfolio construction (blending five asset class funds: Waverton Sterling Bond Fund; Waverton Global Core Equity Fund; Waverton Tactical Equity Fund; Waverton Absolute Return Fund and the Waverton Real Assets Fund) has worked well, allowing for a more sophisticated approach that enables delivery of consistent client outcomes regardless of where the assets are booked.

These measures, and others, whilst costing a few basis points of performance in 2019, made a significant difference to the relative experience of clients in the last quarter. And while this approach doesn’t aim to “knock the ball out of the park” on the way up, it does allow for all to sleep well at night knowing that, as more testing times come, they’re better protected than the hare and they enjoyed more of the journey than the tortoise.

Professional Paraplanner