Independent financial advisers and discretionary investment managers tend to serve retail clients by relying on a very narrow definition of risk profiling. Each client is typically placed into one of between 10 and 30 pre-defined model portfolios and are charged fairly high management fees for the privilege. At ETFmatic, we firmly believe that this combination is not in the client's best interests. This is down to a number of reasons.
Firstly, the standard risk profiling tools used by intermediaries often focus on very narrow measures of risk, such as volatility, or give a broad estimate of acceptable allocations to equity versus fixed income. These broad allocations don’t differentiate between the risk profiles of different markets – such as emerging market equities versus a broad FTSE 100 index, for example. This makes for very blunt risk profiling, and where volatility as a proxy for risk is concerned, the Financial Conduct Authority argues that this is not a sufficient way to measure risk.
Secondly, model portfolios are a crude way to allocate assets for widely differing client objectives. We believe there is a need for a more personalised approach to both risk profiling and investment management.
Step One: Identifying Your Goal
A big noise is made around achieving the best returns. Yet rarely do investors analyse what “best” actually means. To us, it means managing our clients’ investments in a way that they can not only achieve their goals but also have the reassurance that whatever the market conditions, their portfolio is managed precisely in accordance with these goals.
At ETFmatic we allow our clients to define highly granular investment strategies for each goal, including asset allocation, ongoing rebalancing and trade execution. We analyse an investor’s attitude to risk and time horizon. In addition, we will look at the required speed of reaction to market movements as well as the magnitude and direction of trading in response to these developments. And we also ask the client what kind of withdrawal strategy they expect to have once they stop contributing.
This process provides the best possible outcome for each goal given the constraints and is carried out in a highly systematic manner and by keeping operational costs low.
By catering to the mass market, clients can use our services for as little as £50 per month. Also, by reducing the number of portfolio trades and focusing on smart execution, we can lower the total costs to our clients. Clients should be aware that excessive rebalancing affects customer outcomes due to taxes and other factors.
Asset Allocation Drives Returns
Asset allocation is crucial to achieve an investor’s goals and protect their risk-adjusted returns. The chosen mix of different asset class exposures will have a far bigger impact on the investor’s risk-adjusted returns than any individual choice of specific security or fund. Furthermore, the right mix of asset classes, subject to disciplined rebalancing, offers important diversification benefits across a variety of market conditions, while also reducing correlation risks.
Our technology and focus on clients’ goals allows us to avoid sweeping market-orientated rules of thumb e.g. you should determine your equity exposure by subtracting your age from 100. While these guidelines might be useful in avoiding the most common personal finance mistakes, they ignore too many short-term variables and don’t allow the investor to be flexible depending on market conditions.
Portfolio rebalancing is a very important process and is often overlooked. At ETFmatic rebalancing is implemented by an automated trading system.
Focusing the asset allocation on indexes gives us an additional level of flexibility when selecting the most appropriate instruments to use in our portfolio rebalancing process.
ETF providers are well known for continuously driving down their costs and passing these savings on to their customers. As such, we continuously evaluate which ETFs are most appropriate for any given index and incorporate this into the overall rebalancing process.
Drago Indjic is portfolio manager and director at ETFmatic.
ETFmatic offers an investment solution that goes beyond the traditional robo-advisor offering. The company is close to launching throughout Europe.