It’s a commonly held belief that the asset allocation of an investment portfolio determines the majority of the return received by the client.
The decision on what assets form a portfolio and the allocation to each of these fundamentally determines the short-term volatility experienced by the investor. The regulator seems to agree, with their focus upon risk grading clients central to their centralised investment proposition review. But how relevant are these?
The client has been analysed through a risk questionnaire and is invested into these ‘off-the-shelf’ models, which have no awareness of the ‘new normal’ of current capital market conditions.Stochastic models used to compute these asset allocations use past performance as the main driver for their results so how valid are these outputs in today’s market climate?
Most would agree that central bank stimulus in the form of mass liquidity pumped into markets means today’s conditions are somewhat different to those experienced historically.
Multi-percentage point intraday swings are no longer surprising. Traditionally held lower volatility assets are teetering on a precipice of significant capital losses, while cash is only offering a real return erosion of capital.
Yet these same stochastical models still allocate significant amounts of investor’s capital to these same, historically-evidenced, low-risk assets. The client has been analysed through a risk questionnaire and is invested into these ‘off-the-shelf’ models, which have no awareness of the ‘new normal’ of current capital market conditions. This is a risk to wealth which we would suggest is being ignored in the rush to satisfy another compliance box tick.
Andrew Alexander is head of investments at Foresight Portfolio Management
