Pro Finance

Goals-based Investing – A New Approach to an old Question

When discussing a client’s financial planning needs, and specifically what portfolio to establish, an adviser is required to navigate through the client’s specific needs and goals. This is with an ultimate view to provide a portfolio from within the specific discipline and processes that will meet the client’s expectations, while importantly avoiding as much risk as possible.

While focusing on the growth of a portfolio is primarily what an adviser is often engaged to do, especially with historic low bank rates as we face now, a better and more client centric approach is to ensure the clients goals (fiscal or not) are incorporated into their financial plan.

Traditionally, this has been done by aligning these clients’ needs and goals to a risk profile. In turn, this risk profile is aligned with a Strategic Asset Allocation (SAA) where a mix of asset class sectors been applied.

For example, a balanced portfolio has 60% growth assets (shares etc) and 40% income assets (bonds and cash etc). Another layer on this is where fund managers see the market as it sits and apply tilts that underweight or overweight certain assets; this is called the Dynamic Asset Allocation (DAA). Again, for example, a Model Portfolio, for a Balanced Investor, has 57% growth assets and 43% income assets; in effect, a 3% variance.

This process has allowed financial planners and investment advisers to construct a portfolio that sits within their allowed variances of the SAA, while still trying to construct a portfolio with sub-asset classes to meet their goals. This also requires the adviser to be in tune with their client.

While many of these features can be achieved via the portfolio construction and the review / rebalance process, there is a ground swell of movement where such funds can build in the rebalancing function for the client. While these solutions may not make up the entire client portfolio, they certainly may be incorporated into the wider asset management structure.

What is also appealing for some investors, in some cases, are Absolute Return funds. Absolute Return is the return that an asset achieves over a certain period, expressed as a percentage that an asset achieves over a given period. Absolute Return differs from Relative Return because it is concerned with the return of an asset and does not compare it to any other measure or benchmark. Therefore, the saying “you can’t eat relative returns” rings true.

In practice, an Absolute Return fund invests into asset classes its sees appropriate for the time. While it may have an SAA, its DAA may vary totally and as such, it may be a highly traded fund.

Therefore Goals-based funds tend to have a lot more focus on protecting downside risk. This is particularly important for retirees because we all saw what happened in the Global Financial Crisis with more traditional balanced funds. They followed the market straight down . With the growth of KiwiSaver account balances to a point where they provide meaningful income levels for their clients, I see that Goal-based products will provide a natural transition out of the multi-sector funds once income is started to be drawn. This will form a part of the advice process and KiwiSaver Scheme and fund selection process.

While there has been a trend to low cost passive funds in what has been an extended bull market, we see clients now looking to better downside protection in an uncertain market.

In AMP Capital’s article – An Introduction to Goals Based Investing, they say that “The goals-based approach to investing is different as it represents a real shift in the way financial advice is given and the way investment solutions are designed. You could say it’s about turning financial advice and investment products on their head. However, it is important to note that the principles of diversification and risk management are still an important part of the portfolio construction process”.

Investing for sustainable, long-term wealth creation in a changing investment environment requires a different way of thinking. Success in today’s market calls for a more flexible approach and the ability to respond swiftly to change. This means a more dynamic approach to asset allocation and a focus on specific outcomes so investors can achieve their investment goals.

A good adviser will seek the appropriate mix for their client based on their goals. A Goals-based approach is built around helping people accomplish their goals, rather than focusing solely on investment management and performance. Therefore, you can assume that a goal-based fund may indeed be part of the appropriate mix for clients moving forward.