• Risk: the use of passive funds removes the risk of stock specific risk. Active managers would argue they have the opportunity of avoiding underperforming stocks
• Adviser skill: it is important that advisers have a good understanding of the manager’s investment methodology. It is easier to articulate the merits of a passive strategy than an active strategy
Investment style: return focused vs risk targeted
Fundamentally, we distinguish between two types of investment style: ‘return focused’ and ‘risk targeted’:
• Return focused: the fund objective is to beat the performance of a stated benchmark or peer group over time with a broad remit to achieve this objective. Management of risk would not be the first priority
• Risk targeted: the objective for the fund is to achieve returns but against the backdrop of controlled equity exposure and/or volatility level parameters. Management of risk is the priority here. Risk targeted always exists as a range/family with the risk taken varying across the range
Although each style has its own priorities, advisers should expect elements of both to be visible.
Asset types: traditional vs alternatives
Changes in regulation over the past decade have led to fund managers having a lot more flexibility in terms of the asset types they use to construct portfolios, and ‘multi-asset’ investing has almost become the norm.
As most MPS services invest in collectives there is now a more prevalent use of multi-asset investing in this arena too. However, whether traditional or alternative investments are used should be down to the sophistication and expectations of the client.
Things to consider in this area are:
• Traditional: the house preference is to construct portfolios using cash, equities, property and bonds. For less sophisticated clients this may be a more cautious route and provide adequate asset diversification in order to manage risk
• Alternative: the house preference is to construct portfolios using alternative asset types, including private equity and derivatives, in addition to traditional asset types. In times of severe market conditions this may provide additional diversification from non-correlated markets
Management approach: collectives vs direct
The reality is that most MPS services tend to stick to collectives, although there are a few that will invest directly in stock market securities:
• Collectives: the house preference is to research and select managers to run specific mandates within the portfolio (multi-manager). A consequence of this is a very wide stock diversification, which will help with the risk management
• Direct stocks: the house preference is to research and select individual stocks and holdings to construct portfolios. With individual stocks, investment risk is likely to be higher overall as there will be less diversification. However, potential rewards would be higher as there would be less dilution of performance. A judgement needs to be made based on the client’s tolerance
