The launch of Manulife’s goals-based investing program marks a shift in how investors’ portfolios are managed in relationship to their goals, says Bernard Letendre, the firm’s head of wealth and asset management in Canada.SARINYAPINNGAM/istock
Investment-management strategies used in the institutional space have long been beyond the reach of the retail investment industry for serving clients’ needs. Yet, one of these strategies is set to become widely available to financial advisors and their clients thanks to advances in big data analytics and other technological innovations.
That strategy is liability-driven investing (LDI), in which portfolio managers match assets in a portfolio to clients’ future needs – primarily providing income for retirement. Already, some asset-management companies are offering a version of this strategy for individual clients. That includes Manulife Investments, a division of Manulife Asset Management Ltd., which came out with its goals-based investing (GBI) program this past autumn.
The launch of Manulife’s GBI program marks a major shift in how average investors’ portfolios are managed in relationship to their goals, says Bernard Letendre, the firm’s head of wealth and asset management in Canada. “What we’re doing is starting from what the individual’s needs are and then building solutions focused on the outcomes – and those outcomes are [focused on] ‘I need to be able to eat and have money in retirement’ as opposed to ‘I want a return of X [per cent] in a given year.’”
If this explanation sounds vaguely familiar, it should be given that GBI is a core principle of financial planning, says Sylvain Brisebois, senior investment advisor and portfolio manager at BMO Nesbitt Burns Inc. in Ottawa.
“In the retail world,” he says, “the financial planning discipline has been trying to answer this problem for individuals for years.”
Yet, the overarching investment strategy traditionally used to help retail investors achieve their goals is an imperfect match because it was never intended for this purpose, says Mark Yamada, president and CEO of PUR Investing Inc. in Toronto.
Modern portfolio theory underpins most portfolio management strategies used for the majority of investors. Modern portfolio theory is “really an extension of diversification,” only more complex, that seeks to find the most efficient combination of risk and return when constructing a diversified portfolio of stocks and bonds, he says.
American economist Harry Markowitz, who conceived of the idea in the 1950s and won a Nobel Prize in economic sciences, demonstrated how a diversified portfolio of stocks and bonds can provide higher returns while, at the same time, involve less risk than a very conservative portfolio of all government bonds.
“That’s really the effect of diversification,” Mr. Yamada says. “You end up getting better returns for less risk.”
What made modern portfolio theory so popular is that it works brilliantly to grow and preserve wealth slowly.
However, that strategy is not all that well suited for retail investors, Mr. Yamada says. That’s because it must not only grow and preserve investors’ wealth, they also need their portfolios to become sizable enough to meet their income needs throughout retirement. Modern portfolio theory does not address this liability – nor does it address most liabilities average investors might have.
Says Mr. Yamada: “If you want to put your kids through university, for example, and you know that the first kid will be 17 in seven years, how do you invest using this theoretic principle?”
Complicating matters is that most investors have multiple liabilities associated with various financial goals. And each one involves several variables: time horizon, rate of return, volatility and savings rate, just to name a few.
“In the past, we might have lumped all these buckets together and called it one big, balanced portfolio,” says Mr. Brisebois. “But now we’re being asked and tasked to be more specific.”
Although the goals are straightforward, achieving them with specific investment strategies is anything but.
Frequently, the default for these goals is a “balanced” approach of 60 per cent equities and 40 per cent bonds – because it is akin to the Goldilocks strategy of modern portfolio theory. It pursues just enough return while not taking on too much risk.
But Mr. Yamada argues that this asset-allocation strategy is likely to run into trouble; in fact, it already has. He points to 2008 when spiking market volatility prior to the global financial crisis and ensuing stock market crash resulted in investors with this portfolio mix selling stocks and buying fixed income to rebalance to a 60-40 split. Although that approach seems reasonable, these balanced investors – often closer to retirement than further away – got “crushed,” he says.
“Instead, a better approach is starting with finding a volatility people are comfortable with – like bathwater temperature,” Mr. Yamada says
With respect to the aforementioned example, an LDI strategy might involve a mechanism that readjusts the asset mix, based on volatility risk, to 20 per cent equities and 80 per cent fixed income once volatility rose above the long-term average in the middle of 2007.
Of course, the challenge regarding volatility is that “everybody likes their bathwater at a particular [different] temperature,” he adds. And that’s what makes LDI so difficult to customize for small investors; there’s just so much variability to account for with each individual.
Manulife’s GBI products aim to rise to this challenge by leveraging the company’s ample experience in the risk-management business.
“Being an insurance company with 130 years experience of underwriting, we have identified a handful of useful questions to ask clients,” Mr. Letendre says. These include health questions to determine applicants’ morbidity and longevity.
In addition, proprietary software that uses artificial intelligence calculates an income stream that will rise and fall throughout a client’s retirement along with an investment strategy that has a high likelihood of being able to execute this plan.
Rather than focusing on asset allocation and rate of return, Manulife employs what it calls “dynamic liability-driven investing.” In short, this involves allocating a large sum to fixed income to meet cash flow needs at set point in time, such as the first five years of retirement. Mr. Letendre calls this the “LDI hedge.” Then, a smaller sum is invested in equities for growth. This portion is the “dynamic” component of the strategy, he adds.
First to market in Canada, Manulife is offering its GBI products only to clients of its 1,200 Manulife Securities advisors. But other firms, including Mr. Yamada’s PUR Investing, are developing their own versions.
“It takes huge amounts of computing power,” Mr. Yamada says, adding that this can come with a big price tag.
Yet, it’s a quest worth pursuing, he says, because “the big prize will go to the one that can make it the most accessible and understandable for the retail investor.”