The Covid-19 shockwaves that sent markets tumbling earlier this year offered a remarkable demonstration in how model portfolios can quickly rebalance, protect investors and even take advantage of fast, and unexpected rebounds.

Jason Petersen, head of wealth management at 5 Financial, was stunned at the speed with which his model portfolios rebalanced during the sharp selloff, and how they managed to scoop up depressed equity & fixed income assets on the way back up.

“When the equities market dropped dramatically earlier this year, our 50/50 portfolios rebalanced really fast, which was in line with our investment philosophy to help clients stick to their path despite market volatility,” Petersen says.

“But rather than just sitting there and waiting, the rapid market turnaround meant we were suddenly buying at depressed prices, not because we’re cleverer than anyone else, but because the models were following that same philosophy that BlackRock incorporate into their actively managed model portfolios.”

“It might sound strange but for our clients, coronavirus was almost a positive, and added something like four to six per cent back to the clients’ portfolio as a result of the rebalance.”

Automated rebalancing

Model portfolios have gained in popularity in recent years. They allow investment managers to take advantage of a professionally researched mix of managed investments and various asset classes to achieve the requisite diversification for their clients.

Once an investment adviser has determined the clients’ goals & chosen the appropriate model portfolio, the portfolios rebalance automatically according to the model managers process & investment philosophy. This automation of rebalancing all client portfolios reduces the administration and compliance burden for these investment advisers, who can instead focus on managing client relationships and aligning their goals with their financial reality.

When a shock like Covid-19 sweeps through markets, investment advisers are stretched thin trying to calm clients and assure clients to stay the course and withstand the ructions.

“The key is to build portfolio resilience and try to mitigate conditional environments, especially when everyone is taken by surprise like they were earlier this year,” Josh Persky, head of model portfolio solutions at BlackRock Australia, says.

“When there’s a dislocation in markets, it can take an enormous amount of work for investment advisers to respond on behalf of every single client.”

The automated rebalancing of BlackRock’s multi-asset class SMA was one of Petersen’s main attractions to the technology, which 5 Financial implemented into their financial advising business in 2019.

“Rather than being knee deep in manually rebalancing portfolios when the market drops, or writing records of advice, we had time to get on the front foot with clients and explain what was going on,” Petersen says.

Communicate during times of trouble

As Covid-19 forced supply chains around the world to grind to a halt, and huge swathes of developed labour markets were either furloughed or began working in isolation, the news cycle went into overdrive.

Investors around the world tried to digest the onslaught of news, but they also had to translate it to their clients, and steady the knee-jerk reaction to flee the markets towards the safety of cash.

“When things were looking pretty awful, we spent a lot of time sending out broadcasts explaining what was going on and reinforcing our philosophy of staying with the strategy and not selling out at the worst time,” Petersen says.

The 5 Financial staff conducted interviews with the BlackRock investment team, who were able to offer their own market insights, as well as provide clear & succinct explanations as to how the model portfolios took advantage of the market sell off & rebalanced in order to more appropriately retain an investor’s correct asset allocation.

Broadcasting those Zoom interviews to clients gave 5 Financial a firm platform to answer questions and calm fears during a harried and uncertain time.

“Things were looking tough, but the readership of our email blasts and the interview links was remarkable,” Petersen remembers.

“In fact, lots of clients were saying they had some extra money and wondering if they should be investing now, which was really brilliant. We’ve been talking about that for years and years.”

The BlackRock team behind the model portfolio number more than ten across portfolio management, research, investment strategy & risk & quantitative analytics. On a full-time basis, the team manage investment strategy, absorb macroeconomic signals, and implement both tactical investment views at scheduled rebalances, in particular during periods of heightened market volatility.

“During Covid-19, we moved beyond the traditional way of understanding what’s happening in the markets and looked at other tools we had at our disposal,” Persky says.

BlackRock’s team developed a Covid-19 scorecard, establishing a set of new inputs and metrics, including real-time data from John Hopkins University on the number of cases spreading around the world.

The team also looked at satellite imagery, the number of cars driving on the streets in London, Paris and New York, how many people were getting on subways in New York City and tracked listings through job sites.

“We were able to get a good handle on how the virus was affecting not only morbidity & mortality across the globe, but how this was affecting, labour markets, consumer behaviour & even the change in restaurant reservations in individual countries. As a direct result, this gave us confidence in rebalancing the portfolios at the end of March very, very quickly to take advantage of the relief rally in markets,” Persky says.

Dedicating these kinds of resources to understanding the economic impact of a rare event like a global pandemic is critical in a world where investors compete furiously for any informational edge.

“The amount of work it takes to manually manage a portfolio for an investment adviser is astronomical,” Persky says.

“If you’re managing the portfolios of two hundred, or three hundred clients, there are really difficult decisions around prioritising who gets managed first. Model portfolios eliminate those decisions and allow investment advisers to focus on their service offering.”

That service offering itself can also expand, once the scalability of the technology is in place.

While the traditional equities/bonds split is a tried and tested strategy, model portfolios can also include assets beyond developing market, emerging market and Australian equities, and offer exposure to domestic bonds, investment grade global credit, high yielding credit, emerging market debt & equity style factors such as minimum volatility.

Cost considerations

Strategy and structure form the cornerstone of 5 Financial’s offering, and for years the team had bandied about the idea of model portfolios to alleviate some of the administrative burden.

“We are mindful of low turnover, tax efficiencies, low cost and transparency,” Petersen says.

“And we wanted a way to spend a lot more time on strategy rather than the investment piece, but for the last ten years they had been ultra-expensive, which kept us on the backburner.”

But as model portfolios gained in popularity, coupled with the increased proliferation & adoption of Exchange Traded Funds (ETFs) the costs came down, and Petersen could see how the scalability of the technology would strip out costs in his business.

Using a $1 million portfolio as an example, Petersen describes how a 50/50 split between equities and bonds, cash or defensive assets, performed during the sharp market movements earlier this year.

“During the Covid19 shock, those defensive assets went nowhere, and half a million dollars on the equities side dropped by nearly 30 per cent,” he says.

“The model portfolio kicked in to rebalance the $350,000 back to the 50/50 mark, which meant we were buying around $70,000 worth of equities.”

Those equities subsequently recovered by around 20 to 30 per cent, and Petersen says he saw a $15,000 to $20,000 benefit to the client as a result of those purchases.

“And given a $1 million portfolio costs around $1,000 to manage a year, that handling during a crisis more than paid for itself,” he says.

“Rather than lie awake at night wondering what’s going on with the portfolio, it’s been so important for us to spend time with clients.”

But as the cost of the model portfolios came down, Petersen saw how the scalability of the model could enhance his client services offering while also giving him a chance to expand his business.

This ‘InFocus’ article was written in partnership with BlackRock Australia.

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