New model portfolio analysis in Defaqto Engage

Nancy Mills – Insight Support Analyst, Insight and Consulting: Funds and DFM

Earlier this year, we began the process of risk rating model portfolios in the same way as we risk rate funds. We have now risk rated 119 portfolios, from 10 different DFMs, and this number continues to increase.

We look at the model portfolio’s constituents and calculate its expected 10 year forward looking volatility, using the Moody’s projection engine. This is then combined with the historic volatilities and the portfolio manager’s own view, resulting in the portfolio being put into its appropriate risk range. This range is from 1 to 10, with 1 being the lowest risk and 10 being the highest in the scale.

Engage has had the functionality to capture a client’s attitude to risk and then research a suitable multi-asset fund solution for some time. We have now extended this functionality to include model portfolios offered by DFMs.

Engage holds attitude to risk questionnaires from A2Risk (Defaqto default) and Oxford Risk and we have mapped Defaqto’s Risk Ratings to Finametrica’s, so an adviser can also use their questionnaire. Following completion of one of these questionnaires, the client will be given their natural risk level on a scale of 1 to 10, with 1 being the lowest risk and 10 being the highest on that scale. Engage can also accommodate simply choosing a risk level if an adviser prefers to identify this themselves.

A client’s natural risk level is only half the story. Engage will assist the adviser with their conversations around what risk level is most appropriate to meet the client’s objective and the level of investment that is required to meet that objective. The client’s goal details are entered into Engage – target amount, term and initial/recurring payments – and this information, in conjunction with the client’s natural risk level, will project the likely outcomes at the end of the investment term. The adviser can use this information to discuss and illustrate the client’s required level of risk through an interactive session. The parameters of risk and/or investment amount (lump sum and regular contributions) can be adjusted and the impact of those changes can be presented instantly to the client.

Once the adviser and client have agreed which risk level the client should take and how much they should invest, Engage will guide the adviser through to making the most appropriate model portfolio recommendation.

Within Engage, those portfolios that have been risk mapped to the same risk level that has been agreed with the client can be identified. The adviser can then research on this short-list of portfolios as one normally would, taking into account charges, accessibility etc before making a final recommendation.

Performance graphs, asset allocation charts, stochastic modelling graphics and the advisers own justifications can all be used within the generated Client Report.

It is the adviser’s responsibility to ensure the ongoing suitability of their recommendation. Defaqto review each and every risk rated portfolio on a quarterly basis to ensure that it remains within the boundaries for its Risk Rating. Assuming there has been no change in the client’s required risk level, an adviser can be confident that the portfolio remains suitable for their client. A detailed report of this review is available for advisers to download from Engage.

Should the quarterly review highlight that a portfolio is breaching the boundaries for its agreed Risk Rating, this will be highlighted within the report. Where a portfolio continues to breach the boundaries for its Risk Rating for two consecutive quarters, Defaqto will enter into discussions with the portfolio manager to understand the reasons for the breaches. Defaqto’s Investment Committee will meet to discuss the outcomes of these conversations and, if it is deemed appropriate, they will recommend that the risk rating is changed. All those advisers that have made a recommendation via Engage to the affected portfolio will be given notice of any change in the Risk Rating.