Portfolio Risk Controls For Affluent Families How Is My Portfolio Monitored After It’s Setup?

By Mark Barnicutt on March 6, 2020

OVERVIEW:

When constructing portfolios for investors, I believe that there needs to be a thorough process of quantifying their investment goals, understanding their journey in life, and assessing their tolerances to various types of risk.

The output of this process should be the creation of a customized Investment Policy Statement (IPS) for each client, which although it contains a number of key elements, the core focus is on ‘the promise” as to how their portfolio will be managed by their Advisor.

Once a client’s investment portfolio is established, investment firms should have a regular monitoring process to monitor each client’s portfolio to ensure adherence to the standards outlined within each client’s IPS.

The investment industry is famous for having lots of ‘regulatory compliance’ rules – which is good to ensure firms and their advisors are following the rules & laws of the securities industry – but what about the ongoing quality of the portfolios that are created & managed for clients? Having now spent thirty years in the Canadian investment industry, I’m still shocked as to how few firms employ what I would consider to be prudent portfolio risk & monitoring controls in client portfolios.  Additionally, I’m also shocked as to how much latitude, with respect to portfolio risk & monitoring controls, continues to rest with individual advisors instead of with centralized teams within their firms.

A parallel comparison would be the automotive industry.  Nobody would expect that the local dealership through which they purchase their new vehicle would actually manufacture the vehicle because to control the quality of the vehicle, requires a different set of people, technology, skills & experiences which an automotive manufacturer possesses but clearly a local dealership – who sells & services vehicles – lacks. For some reason, though, the investment industry – for the most part – continues to have client portfolio quality controls embedded within their sales branches instead of being objectively monitored within a centralized, independent investment team within a given firm.

PORTFOLIO RISK CONTROLS:

Given this, I believe that there are at least five levels of portfolio risk controls that need to be monitored in client portfolios on a regular basis, and that this monitoring should not be left in the hands of advisors in their local branches but instead within a centralized team within each investment firm, so that when portfolio risk control issues are identified an investment firm can work with the local Advisor and the client to have these issues rectified in a prudent & timely manner.

What follows below are the levels of portfolio monitoring that happen for all HighView clients on a regular basis, through our Portfolio Implementation Team, using advanced technology designed specifically for affluent families and their Investment Policy Statements:

  1. Asset Allocation Monitoring:

Each client’s portfolio will typically have an asset allocation structure to it, normally split across upwards of four broad asset classes: Equities, Fixed Income, Alternatives (ie: private investments) and Cash.

Each client’s IPS contains a “promise” as to what percentage targets will be managed for each Asset Class as a percentage of their overall portfolio as well as how much variation will be permitted around the percentage target.  For instance, let’s assume a client portfolio has two Asset Classes – Equities for 60% and Fixed Income for 40%.  Appropriate portfolio monitoring would regularly ensure that this client’s portfolio is always set at these percentages, subject to some reasonable level of variation due to capital market movements.

  1. Mandate Monitoring:

Each client’s portfolio will also typically be comprised of a series of Investment Mandates, which are effectively the “building blocks” – within each asset class – of a given client’s portfolio.  Example of Investment Mandates include Canadian Bonds, Canadian Equities, Global Equities and Canadian Short-Term Bonds.  As with Asset Allocation monitoring, Mandate Monitoring would ensure that the targeted percentage allocation for each Investment Mandate would be maintained on a regular basis, subject to some reasonable level of variation due to capital market movements.

  1. Security Monitoring:

At HighView Financial Group, each Investment Mandate has a “single” Investment Manager that has been engaged by HighView.  Although we conduct a rigorous Investment Manager Search & Due Diligence Process, once engaged we establish a Statement of Investment Policy & Goals with each Investment Manager.  This document, which is similar to an Investment Policy Statement, spells-out the detailed terms as to how each Investment Manager will operate our Investment Mandate.  Within each Investment Mandate, each Investment Manager is ultimately selecting a set of prudently researched investment securities, typically either equities and/or fixed income securities.  As part of their ongoing portfolio risk management processes, each Investment Manager has a targeted percentage weight of each security within their Investment Mandate.  Although it varies by Investment Mandate, each Investment Manager employs an ongoing process of monitoring what happens when individual securities become overvalued or undervalued.

  1. Cashflow Monitoring:

Many affluent families – especially those who are retired – require a regular & recurring withdrawal of cash flow (ie: interest & dividend income) and potentially profits (ie: capital gains) from their portfolios in order to fund their lifestyle needs.  Additional cash flows can be required irregularly to fund allocations/distributions to family members as well as philanthropic contributions.

Given the importance of maintaining these portfolio distributions for affluent families, it’s imperative that an investment firm actively monitor the level of cash flow and profits being generated within a client portfolio to ensure that those withdrawals are sustainable by the portfolio.  The absence of prudent monitoring of portfolio withdrawals can often lead to an impairment of portfolio capital, if those withdrawals are done at levels that are not sustainable by the portfolio.

  1. Goals Monitoring:

All investors have various investment goals that they are seeking to satisfy such as retirement, or inheritances for children & grandchildren.  Central to the HighView approach to managing client wealth, we construct a client’s overall portfolio such that it is comprised of distinct “goals-based” portfolios.  Regardless of the type of goal, it is our view that all client portfolios have some form of either current and/or future consumption requirement.

As client portfolios “march through time” the Goals-Based Portfolios can reach different levels of relative performance & valuation.  For this reason, HighView will discuss with clients, from time-to-time, the shift of assets, where possible, from goals-based portfolios that have exceeded objectives to goals-based portfolios that require more funding to satisfy investment objectives.  This level of Goals Monitoring is key to successfully helping clients achieve their objectives over time.  That saying, ‘If you can’t measure it, you can’t manage it.’ is true especially in the investment industry.

ADVANTAGES OF PORTFOLIO RISK CONTROLS:

This portfolio monitoring/risk control process provides three advantages to investor clients:

  1. Policy Adherence: It forces ongoing adherence to each client’s customized Investment Policy Statement.
  2. Risk Mitigation: It causes client assets to shift from overvalued areas of their portfolio to undervalued areas.
  3. Goals Focus: It keeps client & Portfolio Manager focused on the purpose of the money…. which is the diligent pursuit of each investor’s goals!

QUESTIONS TO ASK YOUR ADVISOR:

Given the importance of ongoing portfolio risk controls, I believe that investors should ask three questions of their advisors:

  1. What portfolio risk controls, if any, are monitored in my portfolio after it’s setup?
  2. Who monitors these portfolio controls, and what assurances do I have that this monitoring will actually happen?
  3. If portfolio risk control issues are identified in my portfolio, who, how & when are these issues resolved?

If these questions are poorly answered, investors should look elsewhere for their money management services as lacking these portfolio controls can cause serious performance & risk issues for investors in the future.

Mark Barnicutt

As HighView’s President, CEO, and Co-Founder, Mark Barnicutt has thirty years of experience as a Bay Street executive and entrepreneur, with an expertise in the stewardship of family wealth as a mentor to both affluent families and wealth management businesses.
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