Natixis Investment Managers’ UK Portfolio Barometer tracks the activity of 70 UK risk-rated model portfolios in the ‘conservative’, ‘moderate’ and ‘aggressive’ categories. Its latest research found that model portfolios have relatively disproportionate risk profiles stemming from their equities allocations and from a lack of effective diversification from other asset classes and strategies.
20% loss
Data from Natixis’s Portfolio Research and Consulting Group (PRCG) found that in ‘moderate’ portfolios, while equity allocations account for slightly less than 50% by allocation weight, the risk contribution from this allocation is circa 83% – which could mean losses of c.20% in a significant market correction.
Even ‘conservative’ portfolios are subject to increased risks, with c.58% of overall risk coming from equity allocations of c.21%. As a result, in a significant risk event, ‘conservative’ portfolios could see losses exceeding c.10%.
Meanwhile, ‘aggressive’ portfolios are dominated by equity allocations, accounting for c.92% of annual returns and c.94% of risk – implying minimal benefits from diversification outside of equity risk.
The publication of the barometer coincides with research suggesting that informing clients of all of the risks, and not just the greatest ones, can skew the client’s perception of the overall risk involved in an investment.
Open to losses
Andrew Kinsey-Quick, senior consultant, PRCG for Natixis Investment Managers, said: “Clients may not expect a portfolio from the middle of a risk range and marketed as ‘balanced’ to have a possibility of losing c.20% in a significant market correction. In reality, ‘conservative’ portfolios are probably the most balanced in their approach to allocations and risk – to the degree that one could consider them as ‘moderate’ portfolios in their construction and approach.
“In ‘conservative’ portfolios we are seeing a demand for returns pushing investors towards higher risk assets and strategies, with current exposures leaving them open to levels of losses that they may not be prepared for, or fully comprehend.”
Shift from fixed income
Studying historical portfolio allocations from previous barometers, the PRCG found that, over the past three years, advisers have shifted exposure away from traditional defensive assets such as fixed income and into relatively riskier assets such as allocation strategies, alternatives and equities.
This is due to volatility in recent years being underestimated and crucially volatility associated with significant loss events (such as the 2008 Global Financial Crisis).
In the current unexpectedly calm market conditions, simplistic three-year volatility measures are currently much lower than they would have been at the start of the current decade for the very same portfolio construction.
For example, while a ‘moderate’ model portfolio is currently described by a three-year volatility of 6.3%, this same measure would have stood at 11.3% at this point in 2010.
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