Advisers with heavy UK biases in ‘conservative’ portfolios and those switching from government bonds to alternative fixed income strategies to avoid potential interest rate risks may actually doing more harm than good, according to analysis from Natixis Global Asset Management.
The fund group’s first ‘portfolio barometer’ looked at 126 model risk-rated portfolios across 37 UK advisory firms from October to December 2014.
While on the whole adviser portfolios are doing a good job generating outperformance relative to benchmarks with similar levels of risk, strong UK equity bias, particularly in conservative portfolios, may increase overall riskiness.
The firm also found that reallocations due to concerns over rising interest rates may actually lead to a more volatile portfolio, while there was also a greater need for diversification in aggressive portfolios, with alternatives not being widely used.
Speaking to FTAdviser, James Beaumont, head of the portfolio research and consulting group that carried out the research, explained that UK stocks typically accounted for 60 per cent of the equity allocation in conservative portfolios, 40 per cent in moderate and 30 per cent in aggressive.
“We have found that UK equities are not demonstrably less volatile on average than other equity markets, so if the reason for the domestic bias among conservative portfolios is risk aversion, then advisers should reconsider their allocations.”
Anecdotally, after speaking to individual advisers, Mr Beaumont’s team found that because of concerns around future interest rate rises, they had been actively switching allocations out of gilts and in to corporate and high-yield bonds, risk managed alternatives and allocation funds.
He commented that while switching out of longer-dated government bonds will reduce duration risk, many of the replacement asset classes are actually more correlated to equities and will actually reduce portfolio diversification.
“Whilst the returns were good over the period we measured, this lack of diversification may well prove costly in the event of a severe market correction.”
The research also showed inconsistencies in risk levels between different adviser firms, whereby one adviser’s ‘moderate’ model can be another’s ‘aggressive’. Mr Beaumont said it was simply important to be transparent with clients so they are taking the level of risk that they expect.
Benchmarks, while often used to help end investors make sense of what is going on, can actually add to the confusion due to their the sheer number and lack of clarity over their purpose, he added.
Mr Beaumont stated: “The large number of benchmarks being used by different firms could cause trouble for clients trying to compare their portfolios to the rest of the market.
“It is up to advisers to choose the most appropriate and realistic benchmark for their clients’ portfolio, but it does appear a greater level of standardisation is called for.”