Goals-based investing is an emerging way of allocating assets that focuses on funding financial goals instead of getting maximum return. And Canadian investors are taking note.
SEI Investments Company, which launched eight goals-based portfolios in 2012, is working with various Canadian investment dealers to add those funds to their lineups. Meanwhile, Manulife Private Wealth has been generating goals-based performance statements for clients that are typically done manually by other firms.
Then there’s Toron AMI, a boutique wealth player in Toronto, which has been seeing interest in goals-based investing not only from its wealthy clients, but from institutional investors such as pension and endowment fund companies.
“It really started taking off post-crisis, as people realized the behavioural aspects of investing— emotions and biases—played a significant role in their investment decisions,” says Sam Sivarajan, head of investments at Manulife Private Wealth.
Proponents say the concept resonates well with our risk-averse culture, particularly among retirees who want to ensure they maintain their abilities to buy basic necessities and afford leisure when they reach their sunset years.
“We’re finding people more open to looking at risk beyond the absolute return levels,” says Jim Porter, partner and managing director at Toron AMI.
However, the concept has existed in the U.S. for a decade, when behavioural finance experts challenged modern portfolio theory. Goals-based investing measures success based on the portfolio’s ability to meet goals. Assets are split into several portfolios based on those goals, and risk is measured based on the probability of meeting those goals. This runs counter to the traditional method of aggregating all assets into a single portfolio and measuring success against a benchmark.
“The last innovation was target date funds, which addressed one area of the investor’s mindset: when do I need that money [and] what date do I get it?” says Andy Mitchell, who heads asset management distribution at SEI’s Canadian office. And since performance reporting can be confusing for investors, with a goals-based approach, “we can report their progress to their goals,” he says.
Building goals-based portfolios
Advisors can custom-build separate portfolios based on certain goals. For example, a client’s long-term goal could be funding his grandchildren’s educations, and a short-term one could be travelling or purchasing a yacht. The long-term money could be invested in more conservative assets. Meanwhile, short-term money could be invested in growth-focused ones.
So how do you extract a client’s goals? It could get thorny if she has unreasonable expectations or conflicting goals (e.g., couples who have different views on how they want to spend retirement).
Sivarajan says some conversations mean telling clients they can’t reasonably achieve everything on their lists and may need to prioritize between two or three goals, depending on their asset levels.
And in the event of changes that could impact a client’s goal—say, a sudden unforeseen expense in his business—advisors should be ready to make changes to the strategy.
To get these details, Sivarajan suggests some key questions:
- How do you keep busy now?
- What are the things that you hope to do in the next five years? Ten years?
- What do you want to do with your business?
- What are your hopes and dreams for your family?
Make sure to ask follow-up questions, instead of simply going through the list and jotting down notes. Says Sivarajan, “It’s a bit like being a detective. It isn’t just about going through a list of predetermined questions; it’s the follow-up questions that matter.”
Investing for institutions
The approach for goals-based investing is different when it comes to dealing with institutions, such as pension or endowment funds. Unlike individual investors, institutions are subject to controlled benchmarks and committees’ regulations. And there are compliance restrictions they have to adhere to, says Porter.
Institutions’ goals are also different. Some seek to ensure availability of funds for certain projects they’ve committed to, such as a new campus building by 2019. Another could be keeping scholarships funded based on an inflation estimate over a long period.
But with the difficulty of outperforming benchmarks, Porter says CFOs and board members are starting to look for the predictability offered by goals-based investing. Plus, donors are more willing to give if there’s an underlying investment plan to fund the projects they want to support.
Still, some advisors remain unconvinced when it comes to using goals-based portfolios. After all, having goals isn’t consistent with having an integrated approach to building wealth, says Garth Turner, a financial advisor at Raymond James in Toronto. He believes that keeping money in various piles is not a holistic approach to handling finances, and could cause clients to pay more taxes in the long run.
For example, when people place their house money in a saving vehicle—often for years while they wait to buy—taxes and inflation erode what negligible growth they’ve gained, making the purchase even more difficult, says Turner. “In that instance, emotion has led them into a poor decision,” he says, adding a smarter strategy would be to integrate those funds into an overall balanced and diversified investment portfolio.
But for Mark Jasayko, a portfolio manager at Richardson GMP, the greater risk in investing for small outlays would be losing sight of the overall risk management. He says in practice, portfolio managers primarily keep an eye on the individual or the family’s general weighted average risk tolerance. For example, a household with a medium risk tolerance can have a more conservative approach to the RESP account and a more aggressive approach to the main investment account—as long as the tolerance of all accounts sum to medium risk.
But sticking to that general weighted average scale could be tough if the client has numerous goals. “We don’t have the ability to stray from that,” says Jasayko, noting that “everything has to make sense relative to the investment policy statement.”
SAMPLE REPORT for a fictional couple
Net Invested Capital
Portfolio By Goal
Michael & Madeline Baker
Michael & Madeline Baker Joint
Michael Baker Individual
Michael Baker RSP
Michael Baker TFSA
Madeline Baker Individual
Madeline Baker RSP
Madeline Baker Spousal RSP
Madeline Baker TFSA
Michael & Madeline Baker
Michael & Madeline Baker Joint
ABC Holdings Inc. Discretionary
ABC Holdings Inc. Corporate
Source: Manulife Private Wealth
Evelyn Juan is a Toronto-based financial writer.