Portfolio drift remains a clear and present danger for client portfolios

Portfolio drift remains a salient and pressing issue for financial advisers, and while the advent of managed accounts presents a viable measure of control, the challenges of sticking to a ‘paper’ model portfolio when dealing with living, breathing clients still need to be addressed by many financial planning firms.

Why it matters was made clear last week, when we saw massive divergence in the performance of some of Australia’s largest super funds. Despite being run by some of the most qualified investment professionals you could ask for, the difference between the top and bottom performers was as much as four per cent. And that’s with the same asset allocation.

This brings to mind the issue of performance inequity or divergence, which is one of the most worrisome risks I see in financial advice practices – including my own. Financial advice remains a cottage industry in a number of important ways, and without discipline and a very clear focus, client portfolios and their returns can differ significantly.

We all know how it happens. New clients come in at different times with legacy portfolios and their own preferences, all of which cannot be addressed or fixed at the same time. These new clients need to be assimilated with the existing clients on the book, who already understand our process and trust the investment advice we provide, but for several reasons (capital gains, for example) have slightly different portfolios.

With much of the industry still running on an annual rebalancing schedule, and at different times for each client, it’s a challenge to keep portfolios across a client base ‘tight’ and broadly in line to the point that they perform similarly to each other every year.

Like most investment-focused advice practices, we have a paper ‘model’ portfolio which we manage against and keep client portfolios quite in line with this via the delivery of quarterly reviews. There are always laggards, however, and it doesn’t take much for a portfolio to diverge. The risk this presents can become amplified if a client is unavailable for an extended period of time and rebalancing can’t be authorised.

When this happens, it becomes even more difficult to track performance across a business, which links directly to the client experience and their expectations. The result is that every review meeting can be different and therefore more time consuming to prepare for.

This is one of the main reasons we were attracted to the managed account or SMA structure, which essentially converts the ‘paper’ portfolio onto a model is pre-authorised for regular asset allocation tweaks. With a growing cohort of clients, including both self-directed and discretionary investors, this brings consistency and scalability.

Several months into our managed account journey, the benefits are obvious, making both our team and clients happier.

Yet managed accounts aren’t for everyone, and we still have a large portion of our books that aren’t on MDAs. It’s worth noting that thereare also costs associated. These are largely offset by efficiency gains, but they shouldn’t be ignored.

So the issue remains: how to keep on top of portfolio drift? As financial advisers we have a duty to act in the best interests of clients, so doing our utmost in this regard is crucial.

What would the regulator (or AFCA, for that matter) think if a client complained about performance, and it turned out they had a very different portfolio to the rest of your client book?  

Maintaining a tight approved product list can help. Where portfolios are being reviewed at different times throughout the year, the valuations and attractiveness of certain investments changes, making it incredibly important for licensees to maintain a very clear and concise approach.

Regular engagement with clients is also a key alleviator. Content is at the centre of our marketing and growth approach, but also to the day-to-day management of the client experience. This is one of the main reasons we were attracted to the managed account or SMA structure. With a growing cohort of clients, including both self-directed and discretionary investors, consistency enables scalability.

For one reason or another, we harboured trepidation about adopting managed accounts despite the clear benefits both for clients and our business. That said, now several months into our journey, those benefits are obvious.

For advisers managing client portfolios sans managed accounts, the only way to mitigate drift is vigilance. This means more administration, and it will remain problematic as long as clients go away on holidays and don’t return phone calls. The old way to protect against portfolio imbalance works, and it will for some time. It just takes more work.  

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.