When investment markets demand dexterity, model portfolios flex their guns.
After demonstrating their ability to withstand the gales of early 2022, models have built on their continuing popularity as a sturdy option for advisers. As the year draws on, we see more and more presciently the need to have a substantial safeguard to fend against the blow of falling markets.
In this edition of MPS in Focus, we highlight the key strengths of models and the trends shaping a market characterised by intense competition. We speak to advocates both new and old in order to answer the ever-prevailing question of what makes a robust managed portfolio service beneficial.
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Five portfolio construction trends for 2022
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and new recruits
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Model portfolio services: Do it the LGIM way
CONTENT FROM LGIM
sponsored by LGIM
Old hands and new recruits
Want an MPS that is fit for the future? Look out for these six characteristics:
1. A LARGE TOOLKIT
In a world where equities and bonds are correlated and risk abounds, look for providers with a large asset allocation toolkit from which to select the optimal instrument for the implementation of their ideas.
John Bellamy, head of adviser solutions at Waverton Investment Management, advocates for ‘proper’ active management, which has recently manifested itself in inflation and downside hedging.
Waverton’s MPS employs an in-house protection strategy – a long volatility, short equity strategy designed to provide capital protection in severe equity drawdowns. After Covid-19 hit – when inflation expectations were rock bottom – it bought inflation swaps. They have since appreciated almost seven times.
2. A GLOBAL MINDSET
While many investment managers traditionally had a home bias, MPS providers are increasingly adopting a global mindset. Charles Stanley is among those that think having a home bias constrains the opportunity set.
‘We don’t constrain ourselves to a minimum investment in the UK; we simply view all of the opportunities and look for the best risk-adjusted returns,’ says Dan James, the company’s head of asset management.
‘If this means that we have 0% exposure to the FTSE 100 because we believe there’s a better risk-adjusted return to be had in, say, the S&P 500, then we won’t hesitate to implement that position.’
‘We don’t constrain ourselves to a minimum investment
in the UK; we simply view all of the opportunities
and look for the best risk-adjusted returns’
Head of asset management at Charles Stanley
In the right situation, MPS can be a fool-proof way to preserve assets. But as with everything, there are pitfalls, and it helps to know what to look for. Our bite-sized guide is here to help.
3. PRECISE ASSET ALLOCATION
LGIM warns of a ‘concentration conundrum’ that has emerged in equity markets – making models that invest in global indices overly exposed to the US.
‘This is something we’re very conscious of when constructing our portfolios,’ says assistant fund manager Aimee Bowkett. ‘We’d rather gain exposure to global equities in a diversified way by allocating to individual regions and sectors where possible rather than rely on broad global equity funds.’
Investing directly gives even greater control over the risk-return profile while eliminating fund costs. When Waverton wanted exposure to the US car parts sector it invested in a single stock – O’Reilly Automotive.
4. COST COMPETITIVENESS
Cost is a key factor for advisers when evaluating an MPS proposition and has been at the forefront in the battle to secure advisers’ business.
‘Costs add up, and the power of compounding means you don’t just lose the amount paid in fees; you also lose the returns those costs would have generated through time,’ says Craig Burgess, CEO of low-cost, passive provider EBI Portfolios.
‘All costs need to be considered. Running a number of investor scenarios is good practice to see how all the costs affect portfolio performance.’
Chief executive officer at EBI
‘All costs need to be considered. Running a number
of investor scenarios is good practice to see how
all the costs affect portfolio performance’
5. RANGE OF OPTIONS
Does the MPS provider offer a range of options that suit your firm’s own investment philosophy – such as active, passive, income and ethical, and availability across a choice of platforms?
‘To provide both a smoother investment journey and greater choice, you should ensure active or unconstrained, systematic and passive strategies are available with ESG overlays,’ says Ian Hooper, chief investment officer of Progeny Asset Management.
‘The model solutions should be risk-rated to an appropriate risk profiler and available across a wide variety of retail platforms.’
6. GOOD LEVELS OF SERVICE
Look for a level of service that you would expect for the costs incurred. ‘Advisers should ask if a provider will offer individual investment manager support, which could extend to attending meetings with the end client in partnership with their financial adviser,’ says Hooper. ‘Client delivery through technology is also key.’
Ask about response times, too. ‘Being able to get a speedy answer to a technical question from your MPS provider is key to keeping clients well-informed and reassured that their investments are well-managed,’ says Tom Buffham, a portfolio analyst at Brewin Dolphin.
Model portfolios was a concept created at least 15 years ago but fund managers have not rested on their laurels. As a growing number of advisers go down the managed portfolio service (MPS) route and competition in the marketplace intensifies, providers are continuing to innovate.
We spoke to a handful of them to identify the portfolio construction trends shaping 2022 and beyond.
1. RISK REDUCTION
The MPS industry assigns portfolios risk or volatility bands. Covid-19 aside, low stock market volatility in recent years means that some providers may be more leveraged to market direction than investors expect, says Dan James, head of asset management at Charles Stanley.
‘What happens when that volatility structure changes? People will blow out of the top end of the bands and become forced sellers at the point where markets are selling off and potentially less liquid, forcing larger drops in prices just to remain in the prescribed bands,’ he explains. ‘I would rather remain below the lower band for a short period of time and be the buyer of opportunity.’
3. GREATER EFFICIENCY
More efficient portfolio construction can aid diversification while keeping a lid on costs. Last year, PAM launched new models that equally combine the efficiency of BlackRock index funds with the dynamism of its own multi-asset strategies.
‘With a significant equity market rotation underway, inflation biting and bond yields rising, a modern portfolio strategy that can tilt the whole MPS away from areas of greater risk and toward areas of better opportunity can be a valuable source of diversification and protection,’ says Ben Sears, PAM’s head of UK solutions.
‘This can be achieved in a cost-effective way by using an innovative marriage of active and passive engines combined in one portfolio.’
4. FOCUS ON COST
Asset managers typically earn far lower fees on segregated mandates than they do for pooled funds, so the use of mandated accounts can give access to best-in-class managers at keen price points.
Four years after the introduction of segregated mandates to its MPS, Brewin Dolphin continues to see further discounts as its business grows.
Legal & General Investment Management expects the trend around costs to continue – not just lower costs but also a greater understanding of costs. When thinking about cost, it looks not only at headline figures but also potential transaction costs relating to the level of turnover within its model portfolios and underlying funds.
‘What happens when that volatility structure changes? People will blow out of the top end of the bands and become forced sellers at the point where markets are selling off’
Models are continually evolving as fund managers seek to improve efficiency and return on their portfolios
By Jennifer Hill
2. TRUE DIVERSIFICATION
2022 has reminded us of the importance of true diversification. While bonds were once extremely useful in diversifying equity risk, there are periods – such as this year – when equities and bonds fall in tandem.
MPS providers are increasingly finding effective diversification in alternatives. Brewin Dolphin’s MPS uses the recently launched MI Select Managers Alternatives fund, which holds commodities, property, private equity and absolute return strategies.
Pacific Asset Management (PAM) is tactically positioning portfolios to a wider range of asset classes. These include alternatives and diversifying assets, such as absolute return and factor investing.
5. MORE ESG INTEGRATION
The Paris Agreement, Covid-19 pandemic and, more recently, the war in Ukraine, are all among the factors driving exponential growth in ESG investing – making what was once a niche trend the core element of portfolio construction.
Although it is typically harder to reflect in passive portfolios, companies have been working with fund managers to bring in ESG funds that stick to its ethos of passive factor-based investing.
Low-cost provider EBI Portfolios is set to see the launch of two new ESG bond funds this year – the first of their kind in the UK. They will improve the ESG scores of its Earth and Earth UK Bias portfolios.
‘The growth in the quantity and quality of ESG data is leading to better informed decision-making,’ says Craig Burgess, chief executive officer. ‘Potential risk reduction – helping identify opportunities – all with no evidence of performance penalties.’
Head of UK solutions at Pacific Asset Management
‘With a significant equity market rotation underway, a modern portfolio strategy that can tilt the whole MPS away from areas of greater risk and toward areas of better opportunity can be a valuable source of diversification and protection’
This might be the opportunity to reset and make the kind of intuitional changes and policy choices that will lead to a better, greener
and more sustainable future
LGIM’s assistant fund manager Aimee Bowkett and fund manager Francis Chua delve into the inner workings of model portfolios and shine a light on one of the few free lunches in investing.
Assistant Fund Manager,
How and why are advisers using model portfolios these days?
Aimee Bowkett: I think it really depends on a client’s objectives and what makes most sense for them. What we’ve learnt over the last few years, though, is that clients are interested in more than just investment returns.
The growth of ESG is a prime example of that. Today, ESG factors are just as important as the actual returns. Equally, the transparency that model portfolios offer can be really useful for some clients, for example when it comes to holistic portfolio management and tax planning.
Then there’s the way advisers segment their business. In many cases, the ability to provide bespoke model portfolios is an advantage for financial adviser clients. Typically, larger clients prefer bespoke solutions with increased transparency, while slightly smaller clients may find unitised funds more appealing.
What do advisers find most attractive about your model portfolio service?
Francis Chua: One, it’s the breadth of our offering. With our suite of 25 model portfolios, we cover a range of investment styles that cater to the different needs of our clients - all at a competitive pricing point. And two, the portfolios are well diversified, in line with our five pillars of multi-asset investing.
The five pillars of multi-asset investing
• Dynamic asset allocation
• Cost effectiveness
What are those five pillars?
Francis Chua: The first one is suitability, meaning the portfolios have a risk profile in mind. We’re committed to always run the portfolios within that risk profile, which gives the client peace of mind.
The second pillar is dynamic asset allocation. By taking a dynamic asset allocation approach, you not only ensure that the portfolios remain within their risk profiles, but you can also maximise the outcome you aim to deliver for your clients.
Then there’s diversification, also known as the only free lunch in investing. We invest in everything from equities and bonds to absolute return type strategies and alternatives like REITs and listed infrastructure.
What about pillars four and five?
Francis Chua: Number four is cost. We use LGIM’s building blocks, which are very cost-effective and aim to make the most of the compounding effect. As Albert Einstein once said, ‘Compound interest is one of the strongest forces in the universe.’ We want to give clients access to that feature and by keeping an eye to overall costs, we ensure that portfolio returns are not diluted away materially by costs.
The last pillar is engagement. We try to act as stewards for our end investors and influence company actions. We rely on our LGIM index building blocks for that and also invest in external fund managers that have robust ESG beliefs.
How do you select those managers?
Francis Chua: We complement our manager research process with our factor framework. Just like diversification, academic studies have shown that focusing on factors is rewarded over the long term. So why not give clients access to them in a cost-effective way? We focus on five factors, which we also use for portfolio construction: value, quality, low volatility, size and momentum.
You offer both growth and income-focused portfolios. Is one category more popular among advisers than the other?
Aimee Bowkett: We find that our adviser clients are more interested in growth than income. It makes sense because that’s where the majority of assets still sit within the model portfolio space.
That said, we’ve had conversations with clients about income solutions, and we built our income solution for the decumulation phase in retirement. Although we acknowledge that each client’s income needs vary, depending on their individual situation and liabilities. Therefore we think the potential to bespoke model portfolios fits in really nicely with this need for variability in income.
As advisers develop their centralised retirement propositions and the population continues to age, we expect that the demand for income solutions will increase over time.
What investment styles do your growth-focused portfolios cover?
Francis Chua: We have three different ones: index, blended and ESG. The index portfolio invests primarily in the wide universe of LGIM index building blocks.
Blended combines active and passive. While the exposure to active building blocks ranges between 2% and 15% in index portfolios, it’s between 20 and 35% in blended portfolios - so quite a marked shift.
ESG, obviously, focuses on ESG building blocks. As an aside, it is worth noting that we also incorporate ESG considerations in non-ESG portfolios.
How do your model portfolios account for different levels of risk tolerance?
Aimee Bowkett: Each of them targets a different risk profile, based on our proprietary risk management tools. That helps advisers choose the right solution for their clients to match their different risk tolerances.
We manage the portfolios to stay within their risk tolerances at all times to ensure that they have ongoing client suitability, and we do this firstly by setting a long-term, strategic allocation that sits in the middle of the risk profiles. We’re then dynamic with that allocation over time, to ensure the portfolios stay within their risk profiles and take our investment ideas into account.
The risk profiles can also be mapped to external rating agencies if the client chooses so.
How has the relationship between sales teams and advisers changed over the past five years?
Aimee Bowkett: It has become less product and more solutions focused. In the past, the traditional role of a fund manager was primarily targeted towards delivering and the sales team would sell those products to advisers.
Now, it feels like asset managers are much more focused on understanding client objectives and delivering the right client outcomes. Sales teams aid those conversations because they know their clients best.
That’s a really positive development in my opinion. Investing is more than just performance and this is the reason why we launched such a large suite of model portfolios - to encompass lots of different risk profiles and investment styles that can meet a variety of client outcomes.
Are 60/40 portfolios becoming obsolete?
Francis Chua: We think they’re evolving, to put it simply. 60/40 is one of the older generations of multi-asset investing, but the world has changed and the universe of opportunity sets has increased over time.
You can now invest in alternatives or fixed income sub-asset classes like government bonds, credit, high yield, emerging market debt, local and hard currency. If you’re looking to build a balanced portfolio, which is what the 60/40 was there to do, you do need to embrace some of the additional asset classes available to you today.
‘If you’re looking to build a balanced portfolio,
which is what the 60/40 was there to do,
you do need to embrace some of the additional
asset classes available to you today.’
Assistant Fund Manager
‘We find that
clients are more
‘It has become less product and more solutions-focused.’
Tom Munro founded Falkirk-based Tom Munro Financial Solutions 17 years ago and started using MPS a decade ago for mostly affluent clients seeking more active management but not necessarily through a fully bespoke service.
‘MPS is ideal for higher net worth clients with £250,000 or more who are looking for an expected annual return to match cashflow projections; those with less are better suited to multi-asset funds,’ he says.
His actions focused on solutions that could be easily accessed via a platform, mapped to match each client’s risk tolerance and investment strategy.
‘It was essential that portfolios were regularly rebalanced, reflecting constant changes within capital markets to harmonise with our own monitoring for ongoing suitability,’ adds Munro.
‘To respond to clients’ constantly evolving needs, we were also in search of a wider choice of investments and wanted access to active, passive and more recently ESG portfolios.’
Brewin Dolphin was selected and is used to this day. Its seven risk-rated models (cautious, cautious higher equity, income, income higher equity, balanced, growth and global equity) are available as active or passive strategies costing around 0.8% and 0.5% respectively on Transact. It launched ESG options a few years ago.
RELATIVELY RECENT CONVERT
Alister Gaines ran his own advisory models from 2008 to 2012 and managed them on a discretionary basis until 2019.
When he set up his new firm in 2019 – which has since merged with another north-east adviser to form Newcastle’s Greenarch Wealth Management – he wanted it to be led by financial planning. This saw him adopt outsourcing to discretionary managers either on a direct basis or through model portfolios on a platform as his core investment proposition.
‘For the vast majority of clients, the technicalities of the investment solution are not important. Often advisers will try to demonstrate their expertise by focusing too much on investment markets,’ says the director and chartered financial planner.
‘Over the years I’ve seen clients glaze over when I’ve concentrated too much on their investments. Being a financial planning-led firm and using MPS allows us to focus on clients and their needs, where the investment solution is just part of the jigsaw.’
In assessing providers, he focused on three metrics: performance, risk, and cost. ‘I looked for solutions that could provide better return outcomes with lower risk and competitive charges,’ he says.
Greenarch currently uses three MPS providers: Tatton, You Asset Management and Parmenion.
Nick Burt joined London-based Partners Wealth Management as a partner at the start of March. Having been previously restricted to in-house portfolios, he developed a newfound attraction to its use of MPS.
‘I joined from Abrdn, where I was limited to in-house portfolios,’ says the Chartered Financial Planner. ‘Partners Wealth Management’s investment independence gives me the flexibility to recommend any fund house to manage client assets. I find the MPS route to be a very compelling one.’
Among the reasons for his view is his newfound ability to access greater investment expertise at lower cost.
‘Clients and I can benefit from the wider resources of dedicated investment managers,’ he says. ‘Typically, an in-house discretionary service has one to four full-time employees and more limited resources.
‘Moreover, I can access these capabilities at a lower cost. In-house models charged 0.3% per annum, whereas model portfolios may charge as little as 0.125%.’
Partners creates tailored portfolios utilising bespoke ARC research to generate a matrix of leading models. MPS providers it currently uses include Rathbones, 7IM and Waverton.
‘I can have different portfolios in different accounts or a number of portfolios in the same account, providing diversification of managers,’ adds Burt.
‘MPS is ideal for higher net worth clients with £250,000 or more who are looking for an expected annual return to match cashflow projections; those with less are better suited to multi-asset funds’
Director at Tom Munro Financial Solutions
Advisers have adopted managed portfolio service (MPS) solutions at different times. Three of them speak about their experiences.
Director at Newcastle’s Greenarch Wealth Management
Being a financial planning-led firm and using MPS allows us to focus on clients and their needs, where the investment solution is just part of the jigsaw’