Federico Caputo
My recent review of many investors' portfolios prompted the saying "the more things change, the more they stay the same" to keep ringing in my mind. With a new year quickly approaching, investors would do themselves a favour by resolving to avoid some of the portfolio weaknesses I've noticed of late. Doing so is bound to make for smarter investors. Here are a few of the themes that have recently caught my eye.
Di-worsification
A few of the portfolios I've seen exemplified the age-old problem of di-worsification – i.e. a lengthy and scattered list of holdings spread across many different stocks, ETFs and/or mutual funds but also spread about a handful of different brokers or investment dealers. I call this an old problem because I've been seeing this almost since my start in the industry almost two decades ago.
In the late 1990s every portfolio that landed on my desk was a mess – a mutual fund version of a train wreck. I became skilled at what we called portfolio repair. The worst I saw was $150,000 spread across 43 mutual funds. I managed to whittle this down to just 13 funds, improve the performance potential (in my view) and cut fees by 40 basis points annually without triggering any meaningful tax or transaction costs. Amazingly, my colleagues have seen worse.
None of what I've seen recently was quite this extreme, but the problem persists among many investors' portfolios.
No apparent strategy
The most common issue we see in portfolios is the lack of any apparent strategy. Every portfolio my HighView partners and I build for our clients is customized and purpose-driven. The components are standardized in that our preferred Canadian equity manager, for instance, will select stocks for all clients requiring domestic stock exposure. But we customize how we blend investment mandates together for each client – i.e. in a way that lines up a client's investment assets with future spending liabilities. And each mandate plays a well-defined role in helping move the client closer to achieving their portfolio goals.
One portfolio I saw recently had one slice carved out to pick stocks, one dedicated to indexing and one for actively managed mutual funds. I have long advocated smart and efficient blending of indexing and active management but the key word is 'smart'. So when we see a portfolio like this, we struggle to see the underlying thought process.
Active management fees with little chance of outperformance
Related to the previous point, what may on the surface resemble "portfolio diversification" becomes what I refer to as performance dilution. I believe that efforts to 'colour in' every square in the style box has been a key driver of disappointing investor returns. Think of this in the context of a single fund.
If the manager of that fund wants to provide superior performance compared to the broad market from which she chooses investments, she must build a portfolio that looks sufficiently different than the market. Even a concentrated fund typically holds 2- to 3-dozen stocks. Holding four of them all investing in the same market will reduce the likelihood of superior overall performance.
Asset mix with no link to investor goals
I saw another portfolio with a heavy allocation to bonds and cash that we were told had return target of 6 per cent per annum. While the investor and his advisor set a return target, they did not take the important next step of structuring the portfolio to give the investor a real shot at achieving his goal.
By contrast, I estimate that this portfolio had the potential to generate less than 3 per cent per year net of fees. Even allowing for a generous margin of error, it's clear that the process to structure this portfolio either broke down or was haphazard.
Any investor who can avoid these mistakes will be on the path to being a better investor in the new year and beyond.
Dan Hallett, CFA, CFP, is director of asset management for HighView Financial Group and a contributor to thewealthsteward.com.