It was a full house at the Arts Centre Melbourne on 22 October, when IMAP conducted its second Portfolio Management Conference for the year. With 11 sessions on offer, there was a good selection of client-focused investment topics and presentations for managed account professionals. Following are some of the highlights from the Melbourne conference.
Designing portfolios for client goals
Matthew Walker CFP® talks to Anne Hamieh about his approach to goals-based advice.
Q: Why has your business focused on goals-based advice for your clients?
Matthew Walker: After 25 years as a financial planner, you get to see all sorts or markets, ways of operating and the evolution of the industry. At WLM Financial, we do accounting and financial planning. Part of our own evolution has been the cultural aspect of blending those two disciplines together, which means our focus has always been less on sales and more on how we work with our clients to help them achieve their goals.
So, we have focused our business on goals-based advice. And in terms of executing our goals based advice, we have developed a goals based investing business – Dynamic Asset Consulting.
Q: Many advisers would say they are already focused on goals-based advice, by trying to achieve their clients’ needs. How are you doing it differently?
Matthew Walker: I think it’s fair to say that every financial planning firm is about helping their clients achieve their goals. Communication and the nuisances of financial planning is changing. For example, through the managed accounts structure, you have much more flexibility to work with your clients, so the discussions you have with your clients become less about the portfolio and more about their goals.
Where I believe there is a disconnect is when you finish the strategy part of the client meeting and start executing that strategy into portfolios. Clients never come to us and say: ‘What I want to achieve is the ASX 200 and that’s my retirement strategy.’ That just doesn’t happen. It’s the same for ‘balance’ or ‘growth’ or any of these other risk tolerances or benchmarks.
Instead, clients come to us and say: ‘I want to be secure in my retirement. I want regular cashflows. I want to travel. I want to help my children pay off their home loan.’ The conversations with clients are much more human and not portfolio based.
However, the way advisers have traditionally been taught to have these types of conversations with clients revolves around: ‘Hi, how are you? What do you want? How can I help you? These are our services. What is your risk tolerance? Here is your portfolio based on your risk tolerance.’
But in 25 years of advising, I don’t think I have ever met anybody whose risk tolerance perfectly matches up with their financial needs. Therefore, a Strategic Asset Allocation (SAA) type portfolio doesn’t necessarily come together with helping the client achieve their goals. It might if you are just focused on the risk side of things. But from a return point-of-view, it’s a bit more challenging.
Q: Does that mean the SAA approach is not going to work going forward?
Matthew Walker: There is a considered viewpoint that an SAA-type model, which is risk profiling, will struggle going forward. If you think about the very large macro economic picture, such as falling interest rates over the last 30 years, which have been good tail winds for growth assets, property and fixed interest, we are near the bottom of that cycle and have to be close to zero or negative rates.
Considering that environment, building an SAA portfolio that is, by definition, based more on historical returns and correlations, and extrapolating that for what you expect the future rates of return to be, is going to be really hard. So, if you do build an SAA portfolio, unless you do things that are different, or unless you are more dynamic or tactical, an SAA portfolio is going to be challenging.
Q: What approach to investing do you consider will work going forward?
Matthew Walker: It all comes back to goals-based investing. For WLM Financial, goals-based investing was born out of us having a conversation with our clients around what they wanted as part of their financial planning journey.
After the GFC, where you had market volatility and the impact that was having on people’s lives, we knew there had to be a better way of doing things. A lot of products have been developed by institutions that are single asset class and risk profile based, but they actually have no relationship with the client.
So, when we sat down with our clients, we asked them what they wanted. At the end of the day, financial planning is all about helping our clients. They told us: they didn’t want to lose their money, so protection was important to them; they wanted confidence in the process; they wanted transparency in what was happening with their money; and they wanted a return on their investments.
Clients didn’t necessarily want to chase the best return, they just wanted to make sure their money was well looked after and properly managed.
So, if you take all that onboard and look at your clients’ different goals and situations, it’s never a simple matter of having a single goal. It might be saving towards retirement, paying off a home loan, educating the kids, upgrading their house – there are a plethora of goals in life.
The question for us was: if we have all these different goals, how do we then go about matching up those goals to our clients’ portfolios and then execute that? We needed to work out the right way to go about doing that.
We discovered there were fundamentally three different types of goals for clients – retirement, which involved cashflow and liability management; risk, particularly as clients were heading into retirement; and investment return.
So, the challenge was actually bringing these three goals together to produce a cohesive outcome.
You couldn’t really do a risk profile for each goal, because advisers typically only do one overall client risk profile. You can’t say that a client’s kids’ education over the next five years has the same risk profile as their superannuation over the next 30 years. So, how do you build a conservative portfolio and a growth portfolio to satisfy a client’s competing goals? That was challenging.
Q: How do you manage a client’s different goals in their portfolio?
Matthew Walker: We went out to market to see who can deliver on these different client goals. We quickly realised that an SAA style portfolio wasn’t going to work for us, because of different changing economic cycles. So, what do you do?
Well, you have to be dynamic, you need to be flexible, you need to have a broad range of asset classes that you can work within, and not have a restricted APL. You need to be able to execute across a lot of different exchanges.
So, you really need a full toolkit to be able to move into areas where a specific asset is suitable for a particular mandate, allowing you to build a portfolio.
Designing and building structures around a portfolio to suit a client is critical. But how do you execute all that in reality?
We had a look at a number of different approaches we could take, including unit trusts, which is the typical structure in a managed fund. Fortunately, at the time, there weren’t too many unit trusts that could deliver what we wanted to satisfy the different elements of a client’s portfolio.
And while a single unit trust can match up with a single client goal, it didn’t leave us feeling like we had a great value proposition for our clients. A portfolio of one asset doesn’t seem like something that people would pay for.
So, in order to maintain our value proposition, while providing our clients with greater transparency, the solution for us was managed accounts. A managed account provided us with all the benefits of individual ownership, affordability, tax benefits, transparency and flexibility. An MDA licence gave us the flexibility and efficiency with the advice process and executing trades.
A managed accounts solution provided us with the opportunity to execute and scale the business in an efficient way, allowing our planners to get on with the job of being planners, where they can talk about strategy and client goals, and not spend as much time on the portfolio management side of the business.
Q: What does the portfolio construction process look like for your business?
Matthew Walker: We have always aimed to produce the best outcome for our clients, without giving them a rollercoaster ride. As we went through the process of developing our managed accounts solution, we quickly realised we didn’t have the skillset to do it ourselves. We were financial planners, not Chartered Financial Analysts (CFAs).
We simply couldn’t compete with the plethora of full-time analysts and fund managers, who were solely focused on portfolio construction. As a result, we looked to outsource this process, which would immediately free up about 25 per cent of our time, which we could spend on our clients and allow us to generate more revenue.
However, when we first began our journey into managed accounts, unlike today, there wasn’t a lot of choice in the market. Some were doing true-to-label style investing, and some companies were beginning to talk about goals-based investing. But when you looked under the hood of some of these true-to-label offerings, they were more of an SAA with a TAA overlay.
Despite wanting to outsource our managed accounts solution, we couldn’t find the right fit for our business and our clients. So, we ended up setting up a new business – Dynamic Asset Consulting.
This business was separated out of the financial planning business due to any perceived conflicts of interest. Dynamic Asset Consulting put together an investment committee, with independent asset consultants, research houses and a full-time portfolio manager. A lot of resources were invested into this business.
It’s been an interesting journey over the last decade. But if I look back at that journey, I wish there had been been businesses that we could have outsourced this to. However, we have done it now, and through that, we have set up a series of different portfolios that match up with what our clients want. For example, we have cashflow-based portfolios, risk-based portfolios, and return-based portfolios.
It’s important to bear in mind that the choice of platform you use is critical. If you are trying to find a consistent outcome for your client in terms of goals-based, or CPI plus, or a particular level of risk, then you need to be reasonably nimble. You need to be able to get out of the way of approaching ‘train wrecks’ and avoid disasters.
But you also need choice. You need a platform that is able to deliver on things when you want them, like doing direct transactions in the market when you need to make them. You also need the ability to get into IPOs or access new boutique funds. All that is a source of alpha.
Another consideration is whether you can do it across superannuation as well as non-superannuation. A lot of managed accounts are set up for the investment side of the business, but with the super guarantee charge, there are still many people in retail superannuation. So, as an advice firm, we needed a solution that would cover both superannuation and investments as part of a single platform.
So, remember, a single platform that is able to execute across super and non-super, in a consistent and flexible way, is important. And while that may sound obvious, actually finding a platform that can deliver that is quite hard.
Q: How do clients perceive your value proposition?
Matthew Walker: When we first decided to go down the goals-based advice path, by helping our clients match their goals, the first thing we were worried about was clients questioning the assumption that we had always been doing that, and in what ways would we be doing things differently now compared to previously.
However, when we sat down with our clients and explained to them what we were now doing in terms of goals based advice and matching their goals to portfolios, they actually understood it. It made perfect sense to them. They didn’t care about the investment piece. They were more concerned about us delivering to their needs.
We found that the client relationship improved greatly, because we were talking about what they wanted, not investments or market indices, which they weren’t really engaged with.
By having that goals-based advice conversation and relating it back to them, it really improved our client engagement.
When we first introduced goals-based advice, we planned to achieve a 75 per cent client transition rate. We ended up with a 99.8 per cent conversion rate. Only one client didn’t transfer across. So, this was an amazing outcome for the business.
Clients identified that goals-based advice was much easier for them to understand and they could clearly see how it related to them. In fact, in the first 18 months of operating our goals based advice, we achieved a 30 per cent increase in FUM, as clients were happy to invest more with us.
As a result, we now receive less calls from clients about markets and market performance. The conversations with clients are much easier and more personable. It’s easier to manage the investor psychology part of financial planning if you are focused on client goals, as opposed to being focused on an investment.
If you look after your clients, listen to them and help them achieve their goals, you’re going to have an efficient and scaleable business.
Matthew Walker CFP® is a director at WLM Financial and Chair of the investment committee at Dynamic Asset Consulting. Anne Hamieh is Head of Distribution and Marketing at Xplore Wealth.
The risks of retirement income portfolios
Speaking at the IMAP Portfolio Management Conference in Melbourne, Michael Watson, Kris Walesby, Rudi Minbatiwala and Tom Schubert talk about their approach to building retirement income portfolios, including the risks to be aware of.
Q: Why do you think the over-reliance on Australian yield sources is a risk to the long-term predicability of retirement income?
Kris Walseby: One of the main reasons ETFs have taken off over the last five years is because it gives Australian advisers easy ways to play international markets without having to choose single stocks.
This probably boils down to risk. If you are invested in one country, like Australia, and it’s already in a high yield environment, it is typical to stray away from that country.
So, investing in Australia should be weighted relative to other countries.
Remember, Australia is just 2 per cent of the entire world market. There are so many other opportunities for investors from a country, regional or currency perspective. If the blending of these three opportunities is done well, it just means the chance of drawdown through diversification is dramatically reduced.
Australia has enjoyed a long period of relative stability, even during the GFC, where the drawdown wasn’t as high as it was in other countries. But it doesn’t make it immune from those types of threats in the future. Instead, reducing risk by going abroad and entering different markets, and accessing different opportunities, is just savvy investing.
When it comes to asset allocation, this should include a large international exposure, providing greater diversification and safety for clients.
Q: What do you think an average retiree’s portfolio might look like in 5-10 years’ time?
Michael Watson: I think we will see a tilt into other asset classes, both locally and globally, which currently are not really front-of-mind with investors.
Q: Is it wrong to focus on yield, which may produce inferior outcomes for investors?
Rudi Minbatiwala: I don’t think there is anything wrong in searching for yield. I look at yield on my stocks every single day. It’s just that the way we are using that metric has changed. Dividend yield is a valuation metric. However, the way it is used has changed. It’s gone from being a valuation metric to become a proxy for cashflow generation, particularly in equities.
If you think of it on another level, the traditional income asset classes – like credit and bonds – don’t use the same metric. If you talk to any bond or credit manager, they will tell you that it’s not about the running yield, which is the coupon over the bond. You’ve got to look at the yield to maturity or horizon rate return.
It’s interesting that as equity investors, we are using a rule or a valuation metric that traditional income users don’t actually use as a metric.
Michael Watson: From La Trobe’s perspective, we absolutely prioritise capital preservation. Rule number one with investing is don’t lose money, and rule number two is, don’t forget rule number one.
In doing so, we have created products that generate strong running yields on an ongoing basis for investors, because when you’re talking about retirement incomes, having a good strong yield is nothing, if the capital value is volatile.
So, yes, yield is important. Investors who have created portfolios have to live, eat and buy their groceries from the income they generate, which has to last them. That’s why we need to see more diversification across broader assets in order to meet those objectives.
Q: In a low return world, how do you get the right balance between low cost passive strategies and more active strategies?
Kris Walesby: Many people think ETFs are passive but they are probably the most active products you can get and use in an investment strategy. A lot of people don’t understand that. Essentially, using an ETF can mean taking away the active manager’s selection.
If active managers can consistently outperform in any investment environment, particularly around retirement income, you should absolutely pay more for that expertise and ability to outperform the benchmark.
The main thing we talk about with our clients at ETF Securities is to only take the passive if you believe the active isn’t going to significantly outperform. But if you do think it’s going to outperform, then you need to take it or a combination of the two.
Rudi Minbatiwala: I think the definition of value-add in the retirement composition of client portfolios actually matters. Kris is right to say there is an important role for that low cost, transparent market allocation component for a client’s portfolio.
When we’re talking about retirement income portfolios, and we talk about these multiple objectives and timeframes for clients, I think there is value in what else can be done for them.
For example, when we think about whether it’s worth the cost, there are things that can be done within different asset classes, like equities and credit.
I use the term ‘intra asset risk management’, which sits on top of your asset allocation risk management framework. Adding additional layers of risk management is an important part of what retirement income is going to include in a client solution. That’s the framework I use when thinking about whether it’s worth the extra cost.
Michael Watson: There needs to be some sort of thought towards how does that cost link back to performance or the generation of that performance. Some managers in some asset classes are always going to be a touch more hands-on than others, in terms of the asset selection and the investment process. So, therefore, a fund manager in an asset class with a more hands-on approach with their process, will therefore require, a higher management fee.
You need to look beyond the noise of a manager being a touch higher with their fee pricing than other managers, or a manager being priced lower, and basing your decision to go with a manger on price alone. Advisers need to look beyond that. Instead, they need to consider what the manager is actually doing, how are they generating their returns, and whether their approach to investing makes sense.
And if it all makes sense to the adviser, then the notion of cost should be secondary to them.
Kris Walesby: Whether it’s the hands-on approach, the risk management or the scrutiny of funds – it just needs to work. That’s why the use of passive funds have increasingly risen, because there is a long tail end of ultra active management that doesn’t work.
Q: What are your thoughts on managed accounts?
Tom Schubert: The technology and structure of managed accounts enable advice practices to focus on their total return outcome. You can time your cashflows out of portfolios to align with rebalancing events to minimise transaction costs.
And if we’re thinking about preserving capital into the future for our clients and still having an adequately diversified portfolio, then managed accounts are a good avenue to enable that to occur.
Q: Considering retirement incomes, in a low interest rate environment, are retail investors going to be forced into riskier portfolios, as they hunt for yield and returns?
Rudi Minbatiwala: From my perspective, that’s why this topic of retirement income portfolios is so complicated. Yes, equities are being called upon to do so much more heavy lifting in client portfolios, which seems at odds with one of the key retirement objectives, which is lower volatility.
The equities component of an investor’s portfolio dominates the risk contribution of the portfolio. That’s why when we talk about ‘balance’, we’ve got to find a way to de-risk that most risky component of our client portfolios.
However, asset allocation is driving us towards equities because of the yield pressure in some of the other asset classes. So, by doing more within the equities component of a client’s portfolio, can drive value for those clients in that stage of their financial planning.
Kris Walesby: Equities are more risky than most other asset classes. When I came to Australia five years ago, it was obvious to me that many professional Australian investors and retail investors think they are not taking risk with equities. However, when compared with most other regions, they are, in fact, taking a lot of risk.
For example, a conservative portfolio in Germany and Switzerland is made up entirely of bonds and cash. There are no equities included whatsoever. But because Australia is such an equities focused nation, driven by franking credits, equities is hugely popular in this country.
However, equities is an inherent risk, because no-one in Australia has been particularly stung by equities for the last 20 years. It’s almost like a clear and present danger, and investors need to be cautious of that.
Michael Watson is Executive General Manager – Head of Major Clients at La Trobe Financial; Kris Walesby is the CEO of ETF Securities Australia; Rudi Minbatiwala CFA is Head of Equity Income at First Sentier Investors; and Tom Schubert is Managing Partner of Drummond Capital Partners.