It’s all about the process
Alex Funk, Head of Asset Consulting, GCI Asset Management.
Whether the challenge is low growth or complex monetary policy, financial advisors need a strong process to help them deliver the right advice to their clients.
The current low-growth economic environment certainly poses all sorts of challenges for financial advisors and their clients, but then today’s investment environment is generally characterised by extraordinary complexity.
To create the right portfolio in such an environment, I believe that that it’s imperative to be guided by a rigorous and proven process. Choosing the right portfolio is not a simple task. The point is that there is always a set of challenges—if it’s not low growth it will be something else. Advisors need to have the tools in place to understand what their clients goals are, and to construct a portfolio accordingly.
A low-growth environment means lower profits and thus lower dividends. In such an environment, advisors might be tempted to invest in higher risk investments to obtain the growth their clients need.
An added complication in South Africa is that the lower dividends produced by companies are not reflected in share prices on the JSE, which is continually testing new highs. The high price of shares further reduces investment opportunities.
As an aside, my understanding is that the over-valuation of local equity markets can be attributed to the inflows of money currently from the European Union, and previously from the United States. Following the lead of the US Federal Reserve, the European Central Bank is pumping large amounts of cash into the financial system in an attempt to stimulate the local economy. Because the financial system is now global, a lot of that cash is finding its way into emerging markets, which are seen as sources of growth. All this cash is skewing the balance between supply and demand.
Soon enough, the cash will dry up, and we can then expect a correction as share prices align with the actual earnings being produced by companies. Only a highly diversified portfolio will enable an investor to take advantage of the upside and manage downside risk when market volatility increases.
So, how does one go about building such an investment portfolio?
An absolute requirement is the advisor’s independence. Only then will he or she be able to choose exactly the right combination of fund managers to ensure a safe and secure retirement for the client.
The next step is to analyse all the funds—and there are literally thousands globally—in terms of the objectives set for the fund manager. I and my team have developed a scorecard to rate and analyse each fund and the asset management team responsible for managing that portion of money. We also rate the various funds for low correlation. This prevents the ultimate portfolio selection from containing funds with the same aims and style, thus maximising return while mitigating unnecessary risk.
The fund selection is finalised using an asset-liability matching (ALM) model, which takes into account the client’s current assets and compares them with the income the client needs to retire. The ALM model thus shows what return will be required for the current assets to generate the future liability of retirement. Our team then uses an optimising tool to analyse the various combinations of funds that could meet the client’s objectives, and chooses the best one.
I cannot stress enough how important it is for financial advisors to have access to expert asset consulting. This will ensure that they can access in-depth analysis of the multitude of funds available; it will also give them the tools to select the right combination of funds to achieve the client’s goals. Diversification is a key principle, but not for its own sake: it has to be designed to achieve a certain end.
In conclusion, be aware that this is not a once-off activity. Markets change and so do client needs. A regular review is necessary to ensure that the portfolio is still fit for purpose, and this review cycle needs to be part of the process.
