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The nationalisation of some UK banks and the collapse of banks in Iceland have made people painfully aware of the concept of investment risk, which is set to change attitudes towards investment forever.

Consumer confidence has taken a knock and it is likely that clients will now take a far keener interest in exactly where their money is being invested and the level of risk involved.

Throughout its history the Pep and then Isa market has been heavily influenced by past performance and fund pickers. This is why investment themes emerging from time to time conspire to create 'fad' funds or sectors that benefit from sales spikes.

With certain funds and sectors getting much attention and fuss, some investors - especially those acting without personalised advice - invest indiscriminately in 'hot' funds without paying due consideration to the diversification of investment risk. When so much hype is created around a fund it can create the perception that, if you do not invest, then you are going to miss out on the next big thing. The temptation to jump on the bandwagon can be almost irresistible.

While it has always been suspected that this approach may not produce satisfactory outcomes, it has never been put under the microscope.

In order to cast some light on the trend, it was necessary to generate simulations to demonstrate the type of outcomes that may be associated with this kind of investment strategy.

The starting point was to identify the fund that appeared to benefit most from a theme-driven sales spike in each of the past nine years (see table). Even before running any simulation, it was clear there was huge variability in the performance of these funds. The worst-performing fund fell by more than 60 per cent, while the best-performing fund trebled in value. This begged the question: what overall result would have been achieved by progressively investing the entire yearly Isa subscription in whatever the 'hot' fund was?

Although investing progressively on this basis would have increasingly developed diversification, as the portfolio developed over the years, it would also have delivered a very rough investment ride. This outcome would have varied from a 40 per cent profit to a 50 per cent loss over the period measured.

Seeing how the portfolio would have evolved provides a clue why this approach would have delivered such a volatile outcome. Although the profile depicts a diversification of sorts, this has taken time to evolve and has occurred by accident rather than design, illustrating the lack of control investors have over the outcome.

While many of these DIY-style investors would have been encouraged to shun personalised and structured advice in favour of receiving a discount deal, it should be clear that advising clients on this basis is a non-starter as advice is now required to deliver the FSA’s Treating Customers Fairly (TCF) outcomes. Outcomes four and five are particularly relevant in this context:

- Where consumers receive advice, the advice is suitable and takes account of their circumstances.

- Consumers are provided with products that perform as firms have led them to expect, and the associated service is of an acceptable standard and as they have been led to expect.

As the fad-funds approach leads to the possibility of unsatisfactory TCF outcomes with its erratic evolution, it represents a significant but avoidable risk for advisers. An objective and risk-matched approach to portfolio construction will produce more effective diversification and performance aligned with each investor’s expectations. By using risk-based asset allocation tools as proxy for a structured asset allocation approach and making a number of assumptions, it is possible to produce a conceptual comparison with the themed fund approach.

It is assumed each asset class performs in line with the relevant IMA sector average. As a consequence of this assumption, it was not sensible to rebalance the portfolio as there would be no basis for identifying any associated switch costs. Instead, the same profile of subscriptions is assumed as in the first simulation for the "themed" approach.

The risk and return outcomes for all the simulations confirm how effectively a structured approach might manage risk and return compared with the unstructured themed approach. Another key benefit is that the structured approach has effectively differentiated between clients and provides a basis for ensuring the advice is matched to the circumstances. In the era of TCF, it is this consistency that is the real winner for advisers.

If a number of clients at an adviser firm are all found to be willing to take the same level of investment risk, then it makes little sense if each client is found to have invested in very different portfolios. A structured approach will mean an adviser can offer a consistent experience to each client and easily demonstrate the process and research behind each recommendation.

In future, an adviser can efficiently service the rebalancing needs of clients who are all prepared to take the same level of investment risk with bulk switching if they have the necessary authorisation. This rebalancing will ensure that the asset allocation within the portfolio continues to match the client’s attitude to investment risk, and so better manage client expectations.

A historic characteristic of the transactional Isa segment is that investors have typically subscribed to the cash component within their Isa allowance. Although evidence shows this would have improved the outcome, it is sobering to reflect that the risk outcome was the same but returned approximately half as much as the risk nine portfolio. Furthermore, it would also have underperformed the risk three portfolio even though it incurred roughly three times as much risk.

Overall it is clear that a disciplined, well-defined approach to asset allocation can produce positive outcomes that will help reduce the risks associated with providing investment advice. Rebuilding investor confidence in the investment arena will be a challenge, and in communicating the benefits of a well-thought-out approach an adviser can begin delivering messages of reassurance. Portfolios that perform in line with expectations will minimise unwelcome surprises and the anxiety associated with these during periods of extreme volatility, which should help build more stable client relationships and strengthen those that have been long established.

Although the structured approach can produce welcome results, it is important to appreciate that this is underpinned by sector average performance. The key message to take from this is that the focus should be on avoiding sub-average performance rather than hunting top-performing funds, ensuring asset classes are diversified sufficiently to minimise this possibility.

There are a number of ways an adviser can offer a structured approach and establish a defined investment process. Once an approach has been selected, it can be adopted across the firm to provide further consistency for all clients. Some advisers will relish the idea of constructing a portfolio and monitoring the progress, and while there are many investment tools to support advisers who wish to follow this approach, the time, effort and risk associated with this role can be unattractive for some.

Undoubtedly, technology helps facilitate a structured approach, and platforms have flourished as advisers have discovered the benefits of online risk profiling and asset allocation tools. Reporting tools are an important addition to online functionality, allowing advisers to asses a client’s portfolio quickly and present a comprehensive recommendation and the rationale behind it. These reports can ably demonstrate the analysis and consideration that has gone into recommending the right mix of funds to meet the client’s risk profile and investment objectives – making it clear the extent to which the adviser is adding value to the advice process.

Risk-rated funds are another solution that can add structure to a client’s investment strategy. They will provide the rebalancing function within the fund to ensure it remains aligned to the client’s attitude to risk. These funds achieve broad diversification without the transactional complexity associated with a large number of funds within a single fund and are now proving to be an attractive alternative.

The market crash is not the end of the world, but it is the dawn of a new era. Many investors will have been badly wounded by recent events, but it is important not to overreact. Now is the time for professional financial advice to come to the fore and help investors build an investment portfolio that is matched to their individual risk profile and periodically monitored to confirm continuing suitability.

The problem with taking a balanced, structured approach to investment strategy is that during a bull market it looks boring. However, during a bear market boring is exactly what people need.

Peter Jordan is head of proposition marketing at Skandia