Asset Allocation Strategy Workbook FAQs

Transcription

1 C Asset Allocation Strategy Workbook FAQs General Questions about the Asset Allocation Strategy Workbook What are the benefits of using this tool? Why are questionnaires not used? There has been significant criticism of the use of questionnaires (also called portfolio pickers) within the financial planning industry and many licensees are moving away from them.the FPA in its policy position paper on risk profiling have stated that self assessment and questionnaires alone do not satisfy the FSR requirements. Specifically, they do not address any conflicting objectives or lack of understanding that clients may have. It is our view that the previous questionnaire and portfolio pickers in general did not make it easy: for the client to understand how the asset allocation decision was made for the adviser to identify and address inconsistent responses in the questionnaire for a client to understand the impact of their decision on the expected portfolio return and portfolio risk. In short, the likelihood of an inappropriate asset allocation being selected was considered too high. Although these shortcomings were present, we do recognise they could be addressed with further discussions between the client and adviser. It was our experience however that these discussions sometimes didn t take place.the new tool makes the client education process and discussions easier, so these important requirements are met. How should the workbook be used? I sent the workbook in the mail to my client and they were totally confused and did not understand it. The workbook is essentially a tool for you as the adviser and is not designed for the client to complete independently. It should not be mailed or ed to client. The workbook follows the process and provides the explanations an adviser would generally follow and provide when assisting a client to make an asset allocation decision.the approach is however, flexible and ultimately dependent on the education required for the client to make an informed decision. The Worksheets on pages five and seven are the main pages supporting the typical discussion you should have with clients around different asset allocations. Clients are asked to sign and acknowledge the process once completed so we have also tried to word the workbook in a way that makes it easy for clients to understand. What should I do if my clients have trouble understanding the information in the workbook? The risk and return characteristics for the benchmark portfolios do need to be understood by the client. We recognise the information presented may be considerably above the initial level of understanding for some clients and we have therefore prepared a separate Guide to Investment Risk and Return to assist with client education.this guide is written in terms which most clients will understand and can be sent to the client to read independently before the Asset Allocation Workbook is completed. It should be recognised that the information in the workbook should be understood regardless of the process or tools used. Page 1 of 5

2 Why does the workbook contain so much information? As explained above, the workbook is a comprehensive process designed to be a lot more than a questionnaire.the workbook allows you to demonstrate that: you have given the asset allocation decision context in terms of the overall financial planning process you have sufficiently informed the client about the decision they are making you have provided enough information for the client to make the asset allocation decision or agree with your recommendation you have explained how that information has been derived and any limitations of it you have confirmed the client s tolerance to the risk of capital loss in the selected asset allocation you have conducted analysis to assess whether the asset allocation selected is likely to enable the client to meet their objectives (ie gap assessment) the client has undertaken these activities and agreed with the asset allocation selected. I m uncomfortable with a process that doesn t allocate a specific profile. How do I know that this process will protect me in the event of my advice being questioned? Other tools such as questionnaires and FinaMetrica will allocate a specific profile but the providers of these tools will always stress the importance of the other steps required before making an asset allocation decision. For example, the need to educate the client to make an informed decision including a demonstration as to how their objectives will be met, the need to reconcile inconsistent responses or objectives, the risk inherent in the strategy selected to meet those objectives and other potential options. They also stress the importance of having the client involved in the decision making process and not relying solely on the tool to select the asset allocation. This tool attempts to make these outcomes easy to achieve. Compliance Tip: An important area of the workbook that provides the greatest protection for advisers is not being completed, on page eight.the question Did you find that any of your answers to any of the Comfort Test questions covered more than one asset allocation strategy? would often be answered yes. In these instances, it s important to then note the basis for choosing the final asset allocation.you should complete this on behalf of the client, but in words that are meaningful to the client and that relate to discussions that have taken place. Complaint history has shown that advisers have gained a strong defence where they take the time to frame responses in a manner that is specific to each client. How long should this process take? Adviser feedback shows that it takes on average between 15 and 20 minutes to run through this process. Some clients will need more education and this can take much longer. Where advisers may not have previously considered the client s tolerance to the risk of not achieving their objectives, Financial Spectrum now makes this quick and easy. What if the client does not have specific objectives? All clients have some need or purpose for seeking advice. We recognise that clients do not always articulate their objectives in the form required to complete the Asset Allocation Workbook. ASIC states in PS175 that advisers need to help clients articulate their objectives.to do this you will need to quantify and qualify the client s objectives, identifying the relevant information required in the workbook on page three. It s also important to acknowledge that some clients do not have specific financial goals and this is okay. Where the client s objective is wealth accumulation without a specific goal, they may be happy with the return and risks prospects of their preferred portfolio. In cases like this, gap analysis and the completion of page nine is not required. A lot of clients don t have strong views about asset allocation and rely on my advice. How do I get a client to form a preliminary view? We believe the adviser plays an important role in leading, guiding and educating clients. With other risk profiling tools there have been concerns raised about adviser involvement overriding the client s decision.this was a key factor in building the new design, as we recognise that effective risk profiling and asset allocation does include support and guidance from the adviser. We have ensured that this is managed in the client s best Page 2 of 5

3 interests by developing the Comfort Test. By confirming the client s tolerance to the risk of capital loss, there are checks and balances in the process that confirm that the client has made an informed decision. Will this workbook need updating with changing market conditions and outlooks? The workbook and figures will be reviewed each year in January. What are my compliance obligations when a new workbook is issued and I have to review my client? You should review your client s comfort with their asset allocation strategy at each review or where there has been a material change to the client s circumstances.the workbook s design makes reviews easy, as clients who have previously completed the workbook will have an appreciation of the concepts in the workbook. Discussion can then quickly proceed to the Comfort Test and confirmation that clients are in the right portfolio. Recalculation of the figures each year in the workbook should not vary greatly, however, a review should consider the client s progress in achieving their goals in conjunction with the revised forecasts. Compliance Tip: Industry best practice generally recommends that the client s tolerance to risk for their selected asset allocation should be formally assessed every couple of years. Can we do a Comfort Test for each partner of a couple? Yes, but if they are investing jointly, you should show that the clients have reconciled their answers and are comfortable with their decision. What happens if couples disagree? This may indicate the clients shouldn t invest jointly.the adviser should explain that a joint investment will require compromises and assist the clients to prioritise their objectives and concerns. What are my compliance obligations where the client decides to change profiles after they have signed the workbook or during the gap analysis discussion? You should refer the client back to the Asset Allocation Worksheet to confirm the characteristics of their new portfolio and complete a new Comfort Test to confirm the appropriateness of the new profile. Page 3 of 5

4 Questions about the forecast return information in the Asset Allocation Strategy Workbook These figures seem too complicated, how should I explain them to my clients? Even though the basis for these figures is complicated (calculated using a Dividend Discount Model), the basis for the figures is not intended to be explained in detail to clients.the figures should be explained on face value to assist in explanations about investment concepts and compare the different characteristics of each of the portfolios. We have developed some frequently asked questions to assist you to answer any sophisticated or curious client questions that may arise through general discussions. Are these historical or projected returns? These are projected, forecast returns.these risk and return values are merely indicative and in no way provide any guarantees of future risks or performance. The portfolio forecast returns are based on the strategic long-term view of each asset class as at the end of December St.George Investment Solutions uses the methodology of a Dividend Discount Model in forecasting these values.this is based on the analysis of historical market data and fundamental economic factors as best estimates of likely future trends in asset class returns.the forecasts of risk are based on analysis of historical data of risk within each asset class and historical co-variances between the asset classes. What time period has been used for the historical returns in modelling these values? The time period that has been used is ten years, from 1 January 1996 to 31 December What inflation rate has been used? An inflation rate of 2.6% has been used for the Australian asset classes, while the exposure to international asset classes required consideration of relevant economic factors for each country exposed. Why then does the Portfolio Target Return not equate to the Forecast Average Return over the long term? The target return is used as an objective to construct the portfolio, as a minimum expected return regardless of inflation (at any particular time) for the portfolio to achieve within the minimum/recommended timeframe. The forecast average return for each portfolio is based on the return forecast of each asset class within the portfolio and the weight allocated to each asset class within the portfolio. Currently this produces a higher return as the current forecasts are marginally higher then the fund s objectives. How has the likely range of returns been calculated? The likely range of returns has been determined as a range around the long-term expected return of an asset class or a portfolio.the range is developed as a 98% confidence interval on either side of the long-term expected return by applying the exponential growth rate over time. What is a confidence level and what does it really mean? A confidence level is a statistical measure that illustrates the likelihood of an event taking place. In the case of the workbook, it looks at the likelihood of a return falling within the stated range and $100,000 falling within a stated range. Why have you used a 90% confidence level for the projected value of $100,000 for 10 years and a 98% confidence level for the likely range of returns? This educational table on pages five and seven of the workbook was designed primarily to support the education process the adviser undertakes with clients.the higher the confidence level, the higher the likelihood that a return will fall within the range. Consequently, the range will expand to account for the increased possibility of a larger range of outcomes. If you think about a normal distribution curve, such as a bell curve, the majority of results fall within the curve with the more unlikely results measured on the outskirts of the curve. Essentially, as the confidence level increases, the outskirt line widens. Page 4 of 5

5 C Once the ranges and figures had been modelled on a number of confidence levels, judgements were made about which confidence level best illustrated the characteristics of the portfolio and made sense when compared to each other. We decided to use a 98% confidence level for the range of returns for the purposes of educating clients about risk and volatility. However the narrower range of 90% was considered more appropriate to project the value of $100,000 over the long term, ie.10 years plus. Another consideration was the greater the exposure to growth assets, the greater the probability of risks and therefore the greater the range of returns.this meant that the upside and downside for the more defensive strategies was reasonably consistent when using different confidence levels, however Balanced, Growth and High Growth changed considerably. This often looked misleading when translated to a thumb nail scale sketch. It was decided that 90% gave the most accurate representation for the purposes of the workbook.therefore the likely range of returns will not equate to the value of $100,000 invested for 10 years, as the basis of the figures have been calculated using two different confidence levels. How was the probability of a negative return calculated? The probability of negative return has been calculated using a normal distribution of adjusted long term returns, with the mean and the standard deviation derived from the forecasts. Why didn t you use the chance of a negative return in ten as I find this an easier concept to explain to my clients? Adviser feedback was evenly spilt on the approach we should take. We agree the chance of a negative return can be easier to explain and gives the client some perspective to the possibility of a negative return, however, it can also give the impression that negative returns may not follow each other. We decided that the probability of a negative return in any one year helped clients appreciate the likelihood of a negative return and the small probability of this occurring compared to a positive return every year. We felt these values were more consistent and complemented the other information in the workbook. How is the likely time required to recover from this drop calculated? It is calculated as the proportion of the likely maximum drop in capital in any one year by the portfolio s adjusted expected return and the standard deviation. For the answers to question four in the Comfort Test there doesn t seem to be a lot of difference for clients 12 months versus 20 months. These timeframes don t seem very relevant for clients? The spirit of the question is to help clients appreciate in terms of time, how long it would take for their portfolio to rebound to previous levels.these figures are merely statistical calculations, so if there is no material difference for the client, then the client should feel comfortable selecting a higher profile. Consideration should also be given to the reliance the client places on their investments and whether this raises any further considerations. On page two, in the asset class characteristics table, if Fixed Interest can go up and down and there is a medium risk, why is there no capital growth? The long term return of investing in fixed income assets is to ensure a stable income stream and not for the purpose of achieving capital growth, even though capital gains (and losses) can be made in the short to medium term. Disclaimer The information in this publication is intended for the sole use of authorised representatives of Securitor Financial Group Limited (Securitor) or other persons having the express written consent of Securitor. It is not the intention of Securitor that this publication be used as the primary source of readers' information but as an adjunct to their own resources and training. While every effort is made to ensure that the information in this publication is accurate and up to date, Securitor will not be liable to the reader in contract or tort (including for negligence) or otherwise for any loss or damage arising as a result of the reader relying on any such information or recommendation (except in so far as any statutory liability cannot be excluded). Securitor Financial Group Ltd ABN Australian Financial Services Licence No is a wholly owned subsidiary of Asgard Wealth Solutions Ltd ABN , which in turn is a wholly owned subsidiary of St.George Bank Limited ABN CBGGQA20106 Page 5 of 5