Portfolio Construction Conference 2008

Last Wednesday (5^th March), I decided to treat myself to a day out at Arsenal’s Emirates Stadium for the Dealers’ group conference on Portfolio Construction; sad eh? The programme turned out to be informative and challenging (in more ways than one – see later!), but luckily I had Ian Thomas, AXA Elevate’s Head of Proposition, and Al Sherriff, Principal of Cboxx for company. Apart from some dodgy sound management shenanigans (which I managed to avoid by sitting about 2 ft from the presenters position – that’s what happens when you turn up late and have no-where else to sit), Dealer’s group did a pretty good job on this one, and I felt I got value for money – and the free beer at the end was much appreciated too! So, who said what, and did they manage to keep me awake?

Dr Susan Gosling (MLC) – Is modern portfolio theory out of date?

Dr Gosling managed to hit my radar a couple of times and made some good points:

• Just how far back are asset models able to go back for each asset class they are modelling? There’s limited data available for alternative asset classes, so how does this stack up?
• There is insufficient information about risk if you look just at standard deviation; correlation tells us little about how sector returns move relative to each other
• Whilst economic growth and inflation are key drivers in modelling future investment behaviour, investor sentiment (optimism/ pessimism) is also a big factor but one that is also very difficult to cater for
• Multiple scenario analysis provides a more sophisticated view than pure mean variance style stochastic modelling; it even allows for black swans!
• Starting point information affects probable outcomes, i.e. because of where we are right now, inflation is more likely etc.

A straw poll of delegates also revealed that about 40% thought that Modern Portfolio Theory needs tweaking/ to move on. That’s all very well, but I’m afraid that Dr Gosling’s delivery was a tad too dry for a conference opening session, and I heard a few moans in the lunch queue, not least of which was about the incomprehensible Japanese video clips she used toward the end of her session; what was that all about, doc?! Leave it to Clive James next time, eh (is he still alive?)

Jeremy Smilg (UBS) – Private client asset allocation in practice

By common consent, Jeremy was probably the most polished performer on the day, and the contrast between him and the previous presenter could not have been greater! Having said that, if the pitch of his voice had got any higher than the level it eventually ended up at, we might’ve been over-run by Islington’s stray mutt posse! Jeremy hit the high notes with the following observations:

• Clients want hot tips, not to discuss asset allocation
• Although difficult, talking about downside risk is a necessity
• Black swans happen. Frequently.
• Inflation and divorce are the two biggest risks to a client (love that one)
• Some of the portfolios UBS are typically recommending contain up to 45% exposure to alternative asset classes (Hedge funds, Commodities, Private Equity, Real Estate)
• Discussing standard deviation with a client is a waste of time. It’s much better to provide historical back tests (visually) with event overlays (‘this is what happened around the time of the Falklands War’ etc.), and then show how long it took for a portfolio to get above water again. No Belgrano jokes. Please.
• You can either spend a fortune on 40 pages of complex maths, or listen to your granny for free, either way the advice is still the same: don’t put all your eggs in one basket!

Jezza even coped admirably with the obligatory conference tosspot’s inappropriate questions about some local difficulties UBS may have had recently. Thankfully, the moron gave up after the second wind-up attempt. What is it with these conferencetards? Get a life, guy, no-one cared…

Ian Shipway (Thinc) – Managing client expectations I

Ian has gravitas, that’s immediately obvious, and he’s on home territory given the high turn-out from IFP members, so his low-key style is well-received. It’s in stark contrast to Mr Smilg, but it’s on the money and there’s some good stuff to take home:

• The more activity you undertake with a client, the less benefit there is! Sometimes, giving more information to a client is counter-productive. Ian would like to update clients position on cash every day, bonds every 6 months, and equities every ten years (I think that last bit was said with tongue firmly in cheek, but I get the point)
• Need to assess whether what clients want to achieve is realistic (so don’t illustrate using nominal returns!)
• It’s important to show both upside and downside risk; the best and worst annualised returns for rolling periods over different terms can be very educational
• The longer you hold, the narrower the range of outcomes (an observation on practical use of stochastics)
• Showing a client how often the value of their portfolio may be falling is an interesting validation of their risk appetite (Finametrica, Ian’s favourite risk profiling tool, does this very well)
• Dealing with liquidity requirements is quite challenging when designing an appropriate asset allocation
• It’s vital to compare actual experience against expectations by back-testing the financial plan’s performance at annual review time. It’s much better to get clients to compare plan to performance, rather than look at numerical valuations
• Language is important in client communications. What’s wrong with up/down, instead of standard deviation?
• Financial planners also have a role as financial educators
• Need to ask if the client can accept the discipline of long-term investing. Consider how to incentivise clients to stay the course

At the end of Ian’s presentation, a quick straw poll of delegates revealed that most would use cashflow modelling with clients.

Matthew Hunt (Prospect Wealth Management) – Managing client expectations II

I must have been flagging a little at this point, because I’m having trouble remembering Mr Hunt (sorry if you’re reading this! LOL), but I do have my notes:

• Somehow, we have to demystify risk and return for clients
• Avoid using terms such as low, medium and high risk; quantify!
• It’s a good idea to compare client portfolios relative to a benchmark (composite?)
• The costs of active management (both visible and buried) mean that typically managers have to achieve 3% just to break the benchmark
• Active managers need to demonstrate a solid process, i.e. one that is understandable, credible, has risk controls that are applied in practice; track record isn’t as good as a strong process
• Consider how to assess which markets are under or over-valued

Paul Resnik (Finametrica) – feeding investor psychology into client portfolios

When you are introduced as ‘Mad’ Paul Resnik, and a general ‘language’ warning is issued, you have a lot to live up to. Fortunately, Paul had the personality (and the balls) to carry it off; top man! Paul’s observations, delivered with typical aussie humour:

• Client centric financial planning has reached it’s tipping point
• The smart people are now looking at behavioural finance tools
• We’ve made the game too complex
• Portfolios need to be much simpler; passive better than active
• Advisers can’t control markets and product, so don’t take responsibility! Client’s have to bear accountability for their financial plans
• Advisers must move from ‘telling’ to ‘collaborating’

The straw poll this time was around how many delegates were Finametrica users; a lot! At least Paul didn’t hide his motives and was pretty blatant about pitching his product.

Panel session chaired by Hugo Thorman (Ascentric) – Conference themes

Oh dear, this session was a bit of a disaster! I’m afraid Hugo lost control (not sure he ever had it, to be honest), and quite a few delegates subsequently commented that this session bore absolutely no relation to its intended subject! Having said that, there were a couple of bits of sweetcorn:

• Benchmarks that could be used to illustrate performance to a client should cover performance vs cost of living, the market, client lifestyle, and client goals
• Consider whether the data used to power stochastic forecasts is relative to the make up of the investment solution itself (there was a lot of knocking of stochastic modelling in this session)
• Planning tools aren’t supporting the wider range of investments being used
• Do research; do analysis

Was I glad to hear the lunch bell, although the sight of a couple of hundred financial planners troughing it was difficult on the eye! And I do wonder just how interesting it was for the large number of delegates who went and sat in the stadium to watch the sprinklers at work post-lunch…

Panel session chaired by Colin Tipping (BGI) – Best practice portfolio construction

This session was marred by some incredibly inept sound management which made the post-lunch graveyard slot even less tolerable than usual! Being one of the few who could actually hear what was going on, I guess I am privileged to have picked up these nuggets:

• It’s important to use appropriate benchmarks and take care with quality of data, i.e. growth benchmarks for growth funds, and APCIMS is meaningless to a client
• A quick straw poll resulted in the revelation that very few delegates use benchmarks against client portfolios, and an equally small number think they should be used
• Due diligence against planning tools is a big problem; most advisers don’t have the skills or resource necessary to carry it out
• A lot of talk about risky and non-risky assets
• None (yes, really, NONE) of the delegates think fund selection adds any value; it’s all about asset allocation. This may be an inherent bias resulting from heavy IFP presence!
• Managing risk is more important than managing returns
• Institutional techniques are filtering down into the advisory community
• There is a general move towards passive investment solution, and a separation of financial planning from investment management (maybe more IFP bias showing through here)

John Martin (Praemium) – SMAs and rebalancing

This session made Susan Gosling’s look positively inspirational. Jeez John, what were you thinking? I seriously lost the will to live after about 10 minutes, and then the bugger had the temerity/arrogance to over-run as well. I don’t care that you stumped up the cash to sponsor the conference; this was bad, dog (damn, Randy Newman’s American Idol patois is having an undue influence!) Oh, how I longed for a Morecambe & Wise-style crook to appear and wrench this fellow from our collective misery. Didn’t he realise the damage to both himself and Praemium that he was doing? A shocker; say no more…

Nick Edwards (Consultniks) – tax wrappers & portfolios

For about 15 minutes, I was into this. I loved the examples of how different wrappers worked in varying circumstances, but then Nick blew it with a caveat emptor slide revealing the 8/9 potential influencers that killed the lot! And I still don’t know on what basis he ran his CGT calcs – was it using the annual allowance or not? Given the fluid nature of this stuff (“wait until next Wednesday”), I guess this session turned out to be pretty pointless in reality, and the running gag about advising non-doms ‘if there are any left’ got a bit tragic by the end…

Tim Hale (Albion Strategic Consulting) – Planning tools

I was really looking forward to this session given its strong relevance to the work I’m doing at the moment, and the first 5 minutes were full of promise– it looked like Tim was winding up to rip B&H, Tillinghast and Distribution Technology a new one, which would have been interesting. And then he blew it. Imploded. Backed off quicker than the Premier League’s 39^th round … Damn you, Tim, I feel like you stood me up on our first date, but still violated me! You had 20 minutes, and all I got was the need for tools to be transparent, an aid rather than the focus, and that the user needs to control the inputs. Who knew? I’m glad I didn’t pay you for that bit of consultancy. Or maybe I did. Bugger.

Final session – Frontier Capital Management

OK, I admit it, I’d lost it completely at this point. The bar staff had appeared, and my taste buds were getting impatient, so I even missed this guy’s name (Update: it was Bruce Gascoine)! But I didn’t miss the 6 basis points cost of his passive tracker fund range, even though the offshore unapproved status was a bit of a bummer. Get ‘em onshore, guy, in a sensible (approved) vehicle, and you’ll clean up, unless BGI beat you to it! And then it was all over. Plenty of good stuff, and some forgettable performances too (I wish, but I’m still getting Praemium nightmares – stuck for eternity in a Groundhog Day-esque repetition of John Martin’s session). On the whole, I enjoyed the conference, and the good bits validated a lot of my thinking around where financial planning in the UK is heading. Ted Bailey, Dealers group’s new main man in the UK, told me afterwards that he’s planning on putting together a technology-focussed event sometime soon (June 2008?). That’d be interesting if he can get the ’speakers and subjects’ roster on the money; anyone care for a Capita inquisition?! I’d pony up for that… ADDENDUM: Very disappointed in the online resource centre for downloading conference material. So far only 5 sessions have been uploaded. Room for improvement there, Dealers’ group UPDATE: Well done, Dealers group, the vast majority of material from the sessions is now available, and the accompanying blog-based Q&A is shaping up well. Credit where its due…

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