The tendency of high net worth individuals to split their financial affairs among several advisers is one major cause of poor investment decisions and inadequate diversification. At issue here is what diversification means. Too many investors think they’ve diversified their risk, when in fact they’ve simply spread the same risk between several fund managers.
Why diversify?
The purpose of diversifying an investment portfolio is either to reduce the risk for a given expected return or to increase the expected return at a given level of risk, says Johan de Lange, director of Allan Gray Investor Services.
To spread investments successfully, investors should consider a number of aspects, rather than randomly diversifying among managers in the hope of achieving some diversification benefits, he says.
Asset allocation
The first consideration is the asset allocation decision – the mix of shares, property, cash and bonds in a portfolio.
“Due to the uncorrelated nature of the returns of each asset class, asset allocation is likely to make the biggest impact on an investor’s risk/return outcome,” De Lange explains. Investors can diversify across different asset classes either by selecting a “balanced” or multi-asset class fund that matches their broad asset allocation mix requirements but gives the portfolio manager the ability to vary this within certain mandate guidelines; or they can create their own portfolio by buying specialist asset class funds.
Choosing an asset manager
Having made the asset allocation decision, the next area of focus should be the selection of the asset manager and the individual funds. The most important decision is selecting a fund that is likely to deliver strong risk-adjusted returns – it’s one that should be taken in light of a fund’s proven long-term track record. Investors should consider choosing multiple funds if, when combined, they have the effect of reducing risk. De Lange says that to achieve the benefits of diversification, investors should select managers who employ different investment philosophies and styles. “The best strategy is to invest in funds that behave differently under different scenarios, funds that are uncorrelated in their return and their risk profiles.”
Choosing fund managers is one of the biggest challenges for retail investors. Veronica Goodall, asset management consultant at stockbroker BJM, says that all too often the decision is based not on an asset manager’s strength of ability, but on their strength of presence – or the size of their marketing budget. The fact that a brand is all over the media tends to make them top of mind, but Goodall says investors need to look deeper, at the BJMs, the Coronations and the Allan Grays of this world, and not just the biggest players.
Creating the relationship
Goodall explains that unless the investor has a R10 million portfolio, it is likely the relationship with the asset manager, once selected, will be hands-off. “So all the hard work needs to be done upfront in choosing the right manager of your money and placing your trust in them – because there will be no massive personal relationship afterwards,” she says. In BJM’s case, that relationship consists of two roadshows a year, which clients are encouraged to attend and where they can air their questions, as well as regular newsletters and fact sheets.
The bulk of the information is freely available on its website – and so it is with most asset managers. A multimanager such as SYmmETRY does all the fund manager research for the investor, to a depth that no individual could possibly do for himself, and CEO Raymond Berelowitz says there are risks in choosing a fund manager that the average individual could simply never be aware of. In a skills-short country like SA, teams frequently change with profound consequences. If your selection criteria are the asset manager’s performance over the past five years, the loss of key personnel effectively means it is a new team and past performance is no longer relevant.
“In SA, there is a preference for the team-based approach, and changes in personnel affect the credibility of the team so much that you henceforth have to take their performance data with a pinch of salt.
“The average investor would probably never even know of such a change, and even if he did, he might not get the significance. We have the muscle to get plenty of face-time with asset management houses, because we need to understand a team, when there’s a change and whether past performance is still relevant,” Berelowitz says.