Developing the right asset mix for your client can be tricky business. Advisors have to determine their clients’ risk tolerance, closely watch the markets, and there’s the not-so-small matter of making money. So what’s an advisor to do when clients’ portfolios are more volatile than an active volcano? Nothing.
“I focus on the plans we have in place,” says Patrick Murphy, a Calgary- based CFP with Desjardins Financial. “The biggest challenge is reassuring my clients that we’re on track and things are fine.”
Scott Ellison, a Halifax-based CFP and vice-president and portfolio manager with Seamark Asset Management, agrees. He says the most important thing an advisor can do to combat a client’s fears is develop a long-term strategy and stick to it. “It avoids a lot of headaches if you talk about these things ahead of time and go through a process to work with clients and what they’re trying to accomplish,” he explains.
Not altering a portfolio is one thing; creating it in the first place is another story.
Robert Gorman, chief portfolio strategist at TD Waterhouse, says investors should think of themselves as a pension plan. Plans typically have 55% to 65% in equities and the rest in fixed income. These weightings, says Gorman, also work for the average investors.
As well, pension funds deal in the long term. “They have a long time horizon,” says Gorman, who works in the bank’s private client group. “And, they want to generate solid returns without the excessive volatility.”
Gorman reveals that, right now, his average client’s portfolio holds 53% equities and 47% in fixed income, which is a slightly different mix from what he usually suggests.
“It was reflecting a decision to take a bit of risk off the table,” he says. “It reflects the fact that equities will outperform fixed income, but not by a very wide margin.”
Murphy’s current weightings are more in line with Gorman’s typical allocation. His average client has 60% to 65% in equities with the rest in cash and fixed income.
But, most advisors have clients who don’t fall into the “average investor” category. Murphy, Ellison and Gorman have adventureseeking clients who’ve put 100% of their cash in equities, but there are also plenty of more risk-averse people who have more bonds than stocks.
In fact, Gorman says the second- and third-most common investment styles lean conservative, with 40% equities making up the former and 25% equities the latter. That might sound surprising, but taking on less risk is typical of the Canadian investor.
“Historically, Canadians had an even higher percentage of money saved in fixed income,” says Gorman. “If you go back to the early ’90s, interest rates were quite high, so you could generate a fair stream of income with a high total return in a portfolio that was chiefly made up of fixed income.”
While rates have gone down and stock allocations have increased, fixed income is still ingrained in many Canadians as a way to make some money and invest safely. “If you’re not the middle of the road, then most people err on the side of conservatism so they don’t lose what they worked hard to accumulate,” Gorman explains.
Whatever the asset mix division, it is important to figure out how to make your clients’ money work for them by investing in the right funds. Murphy says he often puts his clients into a core Canadian equity fund, with some foreign content, but less U.S. “We’ve been light on the States for quite a while,” he says. “It’s going to take some time after [President] Bush is gone for it to get better, but we’ll have to wait and see.”
Gorman’s portfolios are overweight in Canada, but he’s reduced his domestic stake in recent months. He expects to make more moves out of Canadian funds and into U.S. or other international markets soon. “That reflects the fact that, in all likelihood, Canada won’t outperform indefinitely,” he says.
A balanced Canadian portfolio works well, too, says Ellison, who adds that the asset mix – U.S. versus Canada versus fixed income – is the biggest determinant in how a portfolio will perform.
He says a lot of clients don’t understand this process; they just want to make as much money as possible. In one case he challenged a client who wanted to put all of his cash into equities. Luckily, Ellison talked him out of it, because six months after investing, terrorists attacked the World Trade Center and the markets crumbled. “It was the best piece of advice he had ever gotten,” says Ellison.
That’s not to say there isn’t a time or place for risk-taking. If a client wants to invest in something specific, such as an emerging markets fund, Gorman and Murphy suggest allocating, at the most, 10% of a portfolio to the “pet” investment.
Murphy cites one situation where a client had a hankering for the resource sector. The client, who worked in resources, was already holding a lot of stock in that area outside of the portfolio, so Murphy suggested he buy a diversified resource mutual fund. “We did that, but it was only 10%,” he says. “And that’s worked out quite well.”
Adding small percentages of a sector to a portfolio can be another way to diversify, but it’s not the only way. Murphy likes to spread out his clients’ money among different managers.
“They have different styles,” he says. “I might have a growth manager at one company and a value at another that I like, so I’ll diversify across those two.”
Despite the long-term nature of investing, advisors have a lot of opportunities to tweak a portfolio, especially when it comes to the yearly rebalancing. Ellison enjoys this process in particular, as it gives him a chance to adjust for market conditions and risk tolerance in a way that’s not in reaction to volatility.
“Rebalancing is a huge tool, but only as long as you struck that long-term mix in the first place,” he explains.
Typically, Ellison will review a client’s investments once a year, at which time he’ll make adjustments to the portfolio.
“Bonds have risen and stocks are down so it forces you to rebalance your long-term mix and add when there are good buying opportunities in the market,” he says. “If advisors didn’t have that process in place, the portfolio would just cruise along.”
He adds that, in many cases, he’ll end up selling equity holdings during the review because they grow faster than bonds. “It forces people to sell high and buy bonds back and that means their risk profile is maintained through their investment lifetime.”
Ultimately, managing clients’ expectations is the best way to get satisfying returns. “Focus on the plan,” says Murphy.