Diversification has long been considered a key tenet of a healthy investment portfolio. For financial advisors, are the strategies to reduce clients’ risk changing?
Kevin Hurlburt, executive vice president, products and services, at Mississauga, Ont.-based Investment Planning Counsel Inc., says the notion of a diversified portfolio goes well beyond the classic 60/40 split between equities and fixed-income securities. That’s especially true with more data, analytical tools and products now available.
“We define diversification today as exposure to a range of different asset classes, geographies, styles and strategies,” Mr. Hurlburt says. “This way, investors know there will be something working for their portfolio even when other aspects aren’t working so well.”
Today’s unpredictable market poses another challenge, he says. “We are toward the end of a long and favourable market to invest in. I think diversification is more important than ever from an investor’s perspective.”
In this environment, it may be tempting for advisors to focus more on fixed-income investments such as government or sovereign bonds. But Mr. Hurlburt says it’s important to understand what clients really need and match that to asset allocations.
For example, a client who requires income might be best served with a portfolio made up of high-yield securities, dividend-paying equities, global real estate property and emerging-market debt instruments. For a high-net-worth client concerned about preserving wealth, a diversified portfolio might include hedge funds, infrastructure investments, global real-estate property and private equity.
Given the current state of the market, the methods clients have been comfortable with may no longer be enough to achieve their retirement goals, says Jordan Damiani, senior wealth advisor at Meridian Credit Union in St. Catharines, Ont.
“You have to have discussions with your clients about whether they can make do with less. If they can’t, you’ll need to look at alternative approaches, which may be different from what they’ve done in the past,” Mr. Damiani says.
For instance, a client with a conservative portfolio comprising largely fixed-income assets may need to take on more risk to bolster returns. To stay within this investor’s comfort zone, Mr. Damiani says an advisor might suggest adding equities to the portfolio but keeping them within 30 to 40 per cent of total assets.
Aligning investments to clients’ time horizons is key to building a well-diversified portfolio, he says. Beyond routine reviews, he typically revisits clients’ portfolios when they experience a significant life event – such as a change in employment or marital status, an illness or death in the family – and at frequent intervals approaching their target retirement date.
“If someone who’s been a growth-oriented investor is now three to five years from retirement, I look at reducing that risk level to maybe a more balanced profile,” he says. “Or if it’s someone who lost their job and needs income from investments, we’ll make changes to reduce fluctuations and increase income.”
Lesley Marks, chief investment strategist at BMO Private Banking in Toronto, says building a well-diversified portfolio is easier when advisors can identify what risk looks like relative to an investor’s life and financial goals.
“In the case of younger investors whose objective is capital appreciation, the risk measures would be standard deviation and volatility of returns in asset classes,” she says. “So, you’d be looking to combine asset classes and geography to ensure you have good diversified exposure, and you’d want to look at investing in equities, specifically, more broadly.”
For older investors whose primary objective is to fund retirement, advisors should consider the liquidity risk in their portfolios to ensure on-demand access to funds.
“You’d want a balanced portfolio with fixed-income and exposure to lower-volatility equities, and a mix of geographical exposure, maybe U.S. and potentially global as well,” Ms. Marks says.
Mr. Damiani says advisors need to make sure their clients understand the difference between fluctuations and risk. That’s to ensure clients continue to support their portfolio’s asset allocation, even as certain assets go down in value.
A good way to illustrate the difference to clients is by showing them calendar returns instead of average returns. Doing this can also help advisors and their clients get a better sense of risk tolerance.
“You want to look at how various entities delivered returns over time – were they up and down or were they smooth-going consistently – and whether an investor could stomach similar patterns in the future,” he says.
In today’s volatile markets, the old adage of not putting all your eggs in one basket might hold even greater wisdom for investors. Yet, ensuring a well-diversified portfolio is something advisors should always be working on with their clients.
“This work has to be done ahead of time, instead of chasing returns,” Mr. Damiani says.