A colleague recently asked me to review a new client’s “balanced” portfolio, which had been constructed by the client’s previous planner. To their credit, the previous financial planner felt there were issues with the structure of the portfolio but wanted another opinion to either confirm or alleviate their concerns.
The planner was right and the portfolio had some serious flaws. While the adviser had probably acted in good faith, the outcome was less than ideal.
The first hint that something was wrong came from a review of the largest security holdings in the portfolio.
Of the top ten stocks, five were Australian real estate investment trusts (REITs). Not surprisingly, Westfield was the largest security and, from memory, accounted for around four per cent of the client’s total portfolio. Of the five remaining top ten stocks, two were banks.
Now, aside from making the client’s return experience overly dependent on too few stocks, what amazed me was the domination of the top ten by Australian REITs. This, after all, is a sector that is down over 60 per cent since the end of December 2007 and stocks like Mirvac and Stockland have suffered falls of 86 per cent and 61 per cent respectively.
It made me wonder how large the client’s exposure must have been prior to the sector’s implosion.
And going forward, the sector isn’t out of the woods yet.
That leads me to the second issue I had with the portfolio strategy. Whatever the logic followed by the original planner, the asset allocation within the client’s portfolio was less than industry best practice.
There was a complete absence of global REITs, despite there being over 220 to choose from. Global private equity investments were also missing, denying the client another source of return and diversification. The global equity strategy was also less than ideal as it was a global ex-Australia approach.
I question whether it is good investment practice to prevent your global manager(s) from selecting Australian stocks if they are found to have more attractive investment fundamentals than their global peers. The other problem with the global equities approach was that it was a developed markets only strategy. The client had no exposure to emerging markets where some excellent companies and opportunities reside.
My third issue was with the manager selection. There appeared to be an over reliance on index replication and a skew towards value managers. While there is nothing intrinsically wrong with either, there are some sectors that are highly concentrated – like Australian REITs – where an indexed approach isn’t sensible.
Value based investment styles meanwhile can go through extended periods of underperformance compared with other styles.
This experience goes to the heart of portfolio strategy for anyone or any institution that is constructing client portfolios. Investing in a narrow range of asset classes, and appointing too few managers or manager styles, results in insufficient portfolio diversity.
This can compromise client return outcomes. Hopefully the client’s new planner will consider a more diversified approach.
John Owen is a senior investment specialist with MLC Investment Management.
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