Why I don’t like Model Portfolios

Why I don’t like Model Portfolios

The pace of evolution in the financial advisory industry is accelerating and this is leading to better financial products and improved advice for clients. One of the notable trends in the Irish investment Market over the past 2 years has been the introduction of Model Portfolios. Some of the life assurance companies have designed their own, such as the ‘My Folio’ range from Standard Life. Many high level financial planning firms, particularly those switching to charging fees rather than commissions, are building their own model portfolios, which are specific to each individual firm.

So what are Model Portfolios? When you engage with a Financial Planner, part of the planning process involves research and advice on where to invest pensions and savings. When completing this research, Investment Managers and Financial Advisors start with varying levels of risk appetite, typically from 1-5, (with 1 being very low risk and 5 being very high). They then build 5 portfolios with characteristics that are considered appropriate for each level of risk. These portfolios may involve a combination of active and passive investment funds, cover a range of asset classes and domestic or international fund managers. Your advisor will generally go through a risk profiling questionnaire with you, the results of which will define your appetite for risk. A high number generally indicates a high-risk appetite. This might lead to a recommendation which has a high equity weighting in a pension or investment portfolio.  This process can make sense for a client, as you get a ready-made portfolio, specifically designed for your risk appetite, which is rebalanced and monitored regularly.

So why don’t I like them? I have 4 main reasons

1) Every client is different – Model Portfolios are just that, Models. They assume an ideal portfolio for a client who fits to one of the risk numbers 1-5, 1-7 or whatever range the advisor uses. In my view, after going through hundreds of risk profiling questionnaires, every client is different and they all have vastly different risk profiles. I find it very hard to ‘shoe-horn’ my clients into one of 5 portfolios and invariably make changes or additions to any initial portfolio. Clients have different risk profiles for their pension fund, when compared to their children’s education fund or shorter term savings for a deposit on a house. Therefore, do you give them a range of different models depending on the financial need, and how can you give one risk profile result when the risk appetitive can vary across age, uses for the funds and current circumstances?

2) Market Value  – Model portfolios start by taking a position on asset allocation at a period in time. For example, a cautious portfolio might have 20% Corporate Bonds, 40% Government Bonds, 20%  Equities and another 20% between Alternative Assets and Property. This would be typical of some model portfolios I have seen recently. The problem with these models is they don’t take account of current asset values. Government Bonds are at all-time highs and most would agree they are significantly overvalued at the moment. European Property is still undervalued when looking at long term trends. I would prefer to take this into account when designing and reviewing a portfolio for my clients and this means the portfolio needs to be dynamic. I don’t believe in market timing, but there are very clear moments during market cycles where an asset becomes too expensive, or relatively cheap, and this should be taken into account. Therefore, it is important that there is a regular review of the asset allocation, along with rebalancing of the models if required. This is not always the case in my experience.

3) Other Client Assets – This is probably the primary reason I don’t like Model Portfolios. I have yet to meet a client who arrives in my office with a pot of cash to invest with no other assets. Clients always have legacy pension assets, property, savings bonds etc. The asset allocation of any investment recommendation has to take into account a client’s total net worth. If they are over exposed to, property with existing assets, they will probably not want further property in their new investment / pension. A model portfolio may have a fixed property position built into it. Clients often have legacy equity holdings which for a number of reasons they may not want to liquidate. This should be taken into account when designing a new portfolio.

4) Advisor Convenience – It is obviously convenient and very cost effective for advisory firms to build 5 model portfolios (usually using external investment advice). The Financial Planning industry in the UK, which is more developed than Ireland, use Model Portfolios extensively. One of the main reasons they give for using these models is the ability to ‘scale’ their advice and reduce their costs per client. That may be fine for many advisors, and clients, but I see it’s as being a compromise that reduces the overall quality of advice given.

I prefer to spend a little more time and actually design bespoke portfolios for clients that take into account all the other points made above. It takes more time, is less efficient and my cost my clients slightly more in the initial stages, but it does guarantee that my financial planning recommendations and portfolio recommendations are bespoke, dynamic and focused on the individual client.

In summary, next time you are getting investment advice during a financial review, try to understand exactly how the funds being recommended fit into your overall ‘net worth’. If possible, request your advisor spends a little more time to make sure you have exactly the right investment mix for your personal circumstances.

Thanks for reading!

Dave