Keeping it simple

Mutual funds remain a core investment product used by most Canadians. Whether you invest exclusively in mutual funds or not, this list of portfolio construction dos and don’ts should serve you well.

Start every client engagement with a financial plan

Before you slide a profiling questionnaire in front of a client – and before you start thinking of your investment proposal – start with a financial plan. Think about the investment-management process. Your goal is to figure out what a client wants to accomplish with their wealth, which eventually leads to a target return.

A financial plan will make sure you are using meaningful target returns because they are linked to a client’s goals. Once complete, the financial plan provides direction and context for designing a portfolio that is truly aligned with a client’s objectives.

Think of desired exposures first, then look for products

You get bombarded with new products constantly. But you can’t spend time with all the product sponsors or use all of the products you’re pitched. You need a way to sift through them efficiently. If you first look at your target client segments and your investment and portfolio construction beliefs, you can politely decline the vast majority of pitches and be selective about the products you’ll investigate.

For example, suppose you decided it makes more sense to use broader global-equity strategies than to select individual pieces for U.S., international and emerging-markets equities. If that is your – presumably well-founded – belief, then you can quickly ignore all of the U.S., EAFE and emerging-markets strategies and focus on global mandates that include emerging markets. The same applies for potential additions or replacement managers. I have received several emails over the past year about U.S. all-cap and small-cap strategies. If you’ve seen the same and have the above belief, you can remain uninterested because the strategies don’t align with your philosophy or desired exposure.

Don’t use the “buffet” approach to product selection

Big consulting firms have many good practices. One I don’t like, however, results from their business model and size – their typically long lists of approved managers and strategies. For example, a large firm might have five to 10 Canadian equity managers on their recommended list. Based on the type of client and amount of assets to be allocated, the firm will make a recommendation to allocate across most or all of its recommended managers. This is what I call the “buffet” approach – and most financial advisors do the same thing.

For almost two decades, I have instead been recommending that advisors have greater conviction in their product and manager choices. You need one or two Canadian equity mandates that are used in tandem. But look across your book: chances are you will count several funds primarily invested in Canadian equities. If you conduct a similar review across your book with other product segments, you will likely find a broad array of products. That will lead to inconsistent client experiences across your book.

I’m not suggesting that you give everyone the same portfolio, but you can still customize each client’s portfolio with a tighter list of products.

Don’t use narrowly focused funds

In my early years, I succumbed to the temptation to use small slices of financial markets – some precious metals here, a bit of real estate there, some emerging markets and maybe even a country fund. Fortunately, these were always small allocations, but they were big enough to hurt clients’ portfolios. What I confirmed a short time later was that the vast majority of advisors and do-it-yourself investors are awful at selecting these small pieces of financial markets. And the industry would generally launch new products and promote them after high double-digit (or triple-digit) returns – always the worst time to buy them.

This advice applies to those who believe that active managers have skill. If that active skill exists, it’s likely at the fund manager level – best put to work in broader mandates – not at the level of the retail advisor or individual investor. And if you don’t believe in active management’s value, then surely you can’t believe you are the exception.

Ironically, novice advisors tend to start with simpler portfolio structures and use more complex ones as their knowledge grows. It’s only after years of humbling attempts to get cute that experienced advisors migrate back to simpler portfolio design.

You have lots of value to offer, and these tips should help you focus on what you do best, while avoiding some value-destructive behaviours.

Dan Hallett, CFA, CFP, is vice president and principal with Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for affluent families and institutions.