More than one basket

Ensuring that investments provide enough flexibility is a core part of managing a client’s investment portfolio. For many years, discretionary fund managers (DFM) have argued the benefits of diversifying both the asset allocation as well as the underlying holdings for reaching those goals.

Within an investment portfolio, each asset class has different properties and as such they will probably react differently to changes in economic conditions. Assets that consistently react differently to each other are known as uncorrelated investments.

DFMs will seek to invest in uncorrelated investments as a means of diversification, which will also incorporate a spread of geography, such as investing in businesses or assets in parts of the world outside the UK, (assuming the client is UK resident)
and investing in different industries.

Utility companies, for example, providing services that everyone needs tend to retain their value better in a recession compared with companies offering luxury goods/services. The ability to diversify a portfolio and manage investments with this level of flexibility should reduce the overall volatility of the client’s investment portfolio as well as achieve the client objective.

Offshore bonds, also known as personal bonds, did not always provide much movement to reach the desired diversification. As an established mainstream tax wrapper, they can provide a range of advantages for the underlying client, subject to certain conditions. One of these is that the bond is not ‘highly personalised’ i.e.
the policyholder does not have the ability to select the assets held within the bond (‘policyholder’ can include a person connected with or acting on behalf of them).

Historically, the personal bond rules laid down by HMRC have applied to any UK resident bond investor, which generally means the choice of assets is restricted to certain ‘collectives’ rather than direct equities, bonds and structured products, among others. These restrictions have had an impact on the DFMs’ ability to manage the underlying assets to the requirements of the investor.

But a new open discretionary bond from AXA Wealth International has been structured to allow the DFM to purchase a much wider range of investments while remaining within the offshore wrapper. Given the growth seen in the UK offshore bond market and the increase in adviser outsourcing, this could potentially open up the product to a much wider client base.

Of course, there are parameters that still need to be worked within. The DFM must be aware that, to have these advantages, the underlying client cannot have any influence on the selection of or amount invested in each type of security.

Being able to diversify not only asset allocation but also underlying investment holdings brings an abundance of benefits, though, such as reducing the volatility of the portfolios. The opportunity to use a full range of investment holdings, especially given the rise in popularity of hedge funds, infrastructure and structured products will allow the DFM greater flexibility.

Structured return investments, for example, have become more prominent in discretionary portfolios, given their attractive return profiles. However, this is an area that, historically, DFMs have struggled to implement in offshore bonds given the limited number of collective funds investing in this asset class.

Another other potential advantage to this development in offshore bonds is the possible reduction in portfolios’ total expense ratio (TER) by reducing the need for collective funds with high annual management charges.

Ultimately, the client, adviser and investment manager want the ability to access the best investments at the most competitive cost to achieve the client outcome. Going forward, the open discretionary bond may go some way to achieving this objective.

Claire Bennison is regional director at Brooks Macdonald in Manchester

She writes a regular in-practice article on asset management for Private Client Adviser

This article was published in the February 2014 issue