Friday, May 2, 2008

Put Your Advisor on a Diet

Diversification Drift: The Diabetic Portfolio Syndrome

Imagine if you will a person on a strict diet who is working in a candy shop! Moderation is the key, and every day they remind themselves to be disciplined! It can’t be easy and inevitably most will fall off the wagon!
Well advisors can fall into the same trap! They know that equities need to be constrained to reduce the risk in your portfolio, but gosh they are hard to resist. They just look so good with a gooey analyst buy rating spread over the top!

The key to every great portfolio is to get the asset mix right! Nobody even argues that fact any more as history has proven the impact of asset allocation on portfolio volatility. Asset allocation is the primary reason why good advisors start with a financial plan. From the plan you can determine the rate of return needed by a client, and from that you can build an asset allocation model. In fact almost every investor can dig up an old account set-up and find an asset allocation model they received from their advisor long ago!
I challenge you to do so, and when you find it if you are over-weighted in equities please send me a nickel…..forgive me, I will have to write quickly as I am expecting a deluge of coin soon and might be retiring by the end of the week!

So why does it happen? Why would advisors increase the riskiest component of a portfolio above the agreed to targets! Well, advisors are only human. They are bombarded daily with equity recommendations from their bosses, their research departments, BNN, the newspapers and even from clients looking for the next Google! Combine that with the sugar high of big fat commissions and trailer fees and it is a wonder investors ever even know what a bond is! Equities are the sizzle; bonds are the roughage.

Slowly but insidiously, the equity component rises in the portfolio. Fortunately rebalancing should prevent the damage from being too severe or long lasting. Alas, rebalancing is a lot like exercise. It might be good for you, but somehow it keeps getting pushed to the bottom of the “to-do list”. That same old account set-up you found may well list the rebalancing schedule that hasn’t happened and the semi-annual face to face meeting that was not deemed necessary. All these non-events contribute to allowing the equity assets to become the fat kid of the asset class!

Probably my favourite ongoing example of equity drift occurs when I look at an E. J. statement. The statement lists the target for every asset class in the account;and beside that percentage is the actual weighting in the portfolio. It is amazing that clients don’t seem to rebel at the discrepancy from what the E.J. statement recommends and what the advisor actually has them holding!
Now I am sure not every E.J. Advisor is recommending clients be over-weighted in equities and it is probably just my small sample that distorts the fine work they do. I will say the E.J. statements at least show the recommended asset weighting which is more than many of the big brokers do!

So what is an investor to do? Put your advisor on an equity diet. And like any good dietician, have them check in for a semi-annual review to ensure they have not bulked up by nibbling on too many IPO’s or equity buffets. It may be your advisors diet, but the impact of too many equities will damage your portfolio long before your advisor shows any symptoms!

p.s. Beware structured notes which claim to be roughage but are filled with sugary equities and laced with fees!

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