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Allocation, allocation, allocation

Modelling tools can shine a light into the vital area of setting an asset allocation strategy for IFAs.

The retail financial services industry is in a state of flux and the advice sector is being hit hardest.

Although turbulence is buffeting all types of adviser, I want to deal primarily with the more sheltered parts of the market where many IFAs are focusing, principally by aiming to provide an added-value investment service over the long term. This may sound vague but it is about alignment. To provide a long-term service, the economic interests of the adviser must chime with those of the client.

If one considers the scope of financial advice in an asset accumulation context, it is clear there are two main areas for consideration – tax and asset selection, with investment processes vital in the latter.

In essence, every initial and ongoing investment procedure consists of asset selection and asset allocation. Historically, these have been bundled together with balanced managed and with-profits funds but multi-manager funds have begun to challenge them. In practice, this will make no difference. With any of these “solutions”, invest-ors’ personal requirements are pretty much ignored.

Academic studies suggest that more than 90 per cent of outperformance is derived from asset allocation so IFAs wanting to meet client expectations need to claim at least some of the asset allocation element in the value chain. But are they?Many claim to be investment experts but the majority still believe their real area of expertise lies in selecting funds. How many have developed a robust process for assessing clients’ attitudes to risk, enabling the adviser to produce an appropriate asset allocation model? What this means is that the best fund selection efforts of IFAs are often being wasted. Without a suitable asset allocation strategy, even the most successful approach to fund selection will bleed performance against a well allocated portfolio.

How can IFAs make appropriate asset allocation decisions?Recent months have seen the emergence of portfolio construction tools based on stochastic modelling techniques. Essentially, this involves running dozens, hundreds or thousands of simulations of potential returns from various asset classes, giving a probability distribution of the possible returns.

This allows IFAs to advise clients on the most appropriate asset allocation to meet their goals, within appropriate risk parameters. The concept can be extended to create model portfolios which can meet the requirements of groups of similar investors over a period of time – meaning that customers unable to afford a fully bespoke advice service can still benefit from the modelling techniques, if they have some means of quantifying their attitude to risk.

The net result? For the first time, it is possible to provide members of group arrangements with default options rather more appealing than “balanced” managed funds, where the average exposure to UK equities is in excess of 80 per cent (Lipper Life Office Asset Allocation Analysis, Volume XII/10). Is that really where IFAs want to invest their clients’ money?In addition, there is now a significant problem with many investors in defined-contribution pension schemes becoming unwittingly heavily invested in high-risk asset classes. Scottish Life has resolved to take a different approach and now enables IFAs to invest according to their clients’ attitude to risk and time to retirement.

Crucially, the modelling tools we used are not just about the initial sale. They help IFAs work with their clients on an ongoing basis to ensure the asset allocation strategy which was initially applied to a portfolio remains appropriate.

An IFA can transform a business from being heavily dependent on up-front commission into an operation far more alive to the interests of clients. Bear in mind that a business with very large trail commission income, coupled with a significant number of satisfied customers, will be worth far more than one which is reliant on attracting the next piece of business.

This must be the principal objective of any IFA seeking to improve professionalism. Advisers who run a sales-orientated business will find it far more economically attractive to tie.

The issue for many IFAs is which type of adviser do they really want to be? Making vague noises about offering a better long-term service is easy but a half-hearted approach will fail because client satisfaction will be non-existent and costs will remain high. A successful transition requires using software and tools to ensure all clients benefit from a similar process.

Once this has been achieved, the IFA can expect to experience a dramatic uplift in the value of the business as many costs will be covered by recurring income which, provided that a good service is offered and markets do not plummet, is clearly stronger revenue than a series of initial commission relating to new business.

The tools are now available to make this a reality. All that is needed is the will of the IFA community.


Tom Baigrie on protection

How many times have you had to make a call or arrange a new meeting with a client to tell them of an unexpected loading, exclusion or decline? The way to avoid it is to set their expectations properly at outset you have to know quite a lot about underwriting.


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