Investments Funds Methodology

Traditionally portfolio selection has evolved around choosing the best investment funds per asset class. At Clifford Osborne in Eastbourne, East Sussex, our Independent Financial Advisors (IFA) believe that active funds offer diversification benefits over and above what can be obtained from the asset class and that this characteristic, properly harnessed, is extremely valuable. To arrange a free initial discussion at your home, workplace or our offices contact us today.

By carefully selecting the right mix of active investment funds, we are able to diversify away more risk than the asset allocation model alone would be able to, leaving us a little bit extra in our risk budget to spend on more exciting investments that drive returns while still sticking rigidly to the desired risk profile.

Using diversification technology to exploit the differences in investment fund managers’ styles, strategies and view points to maximise diversification, coupled with the traditional actuarial input into asset allocation, results in solid, robust portfolios that make sure you get the most from active investments fund management.

Each portfolio must conform to a strict risk target which is regularly reviewed to ensure that investors continue to have confidence in their investments. In total there are 15 portfolios split across five risk levels and three time horizons, short, medium and long.

Our portfolios consist only of investment funds that are included in the FE Select 100 list of funds, which we deem to be outstanding investment choices. Additionally, in a bid to aid stability, only funds in the top two-thirds of this list are considered for the portfolios because, while we regard all funds on the list as suitable, we do not want the removal of funds from the FE Select 100 to cause unnecessary portfolio turnover.

The FE Select 100 range is created using FE’s in-house rating systems, combining FE Crown Fund Ratings, FE Alpha Manager Ratings, FE Group Ratings and the AFI which contains investment fund recommendations from a panel of leading financial advisers.

These four scores are then combined to provide an overall fund score. From this the top 100 funds are selected ensuring they are spread across a broad range of asset classes.

The advantage of selecting the investment funds using a quantitative rating system is to ensure the list remains free of any prejudice or bias and simply reflects the best funds. The ratings used are updated regularly ensuring that the FE Select 100 comprises the best funds possible.

Finally to ensure that our portfolios can be easily constructed, we only use funds that are available on all the main platforms and check availability regularly.

Clifford Osborne is based in Eastbourne, East Sussex, and has clients across Hastings, Seaford, Lewes, Bexhill, Newhaven, Uckfield, Crowborough, Brighton, Hove and Tunbridge Wells as well as further afield.

Portfolio Size and Risk Targets

Our portfolios consist of 10 funds, which is regarded as the optimal number to maximise diversification benefits. With fewer than eight funds, analysis shows it is not possible to diversify enough, but with more than 12 funds there is no additional diversification benefit and the portfolio return converges to average.

In a 10-fund portfolio, even under-performing funds make a valuable contribution by providing diversification that reduces the overall risk of the portfolio. Each portfolio has the target of having the same, or lower, amount of volatility as the asset mix recommended for the forecasted target risk level. By matching the short-term volatility of the appropriate asset mix, we can be confident of meeting the long-term recommended volatility target.

Investing for Growth

Our growth portfolios are built to a volatility target that is designed to integrate with the volatility levels produced by the most popular risk-profiling tools and ensure investors are always exposed to the appropriate amount of risk and can provide a forecast of future volatility based on expectations of the behaviour of asset classes.

Investing for Income

In addition to the 15 growth portfolios we have an income portfolio. Unlike the other portfolios this is not managed to a volatility target; however it does have specific objectives. These are to produce a yield of three to three and a half per cent a year and to preserve the capital value of the portfolio in line with inflation on a rolling five year basis.

Unlike our growth portfolios there are not different portfolios for different risk levels. The nature of an income portfolio means they are not suited to the traditional way of measuring risk. The analysis indicates that the portfolio very quickly gets to a level where the more risk that you take the lower the income is paid out.

Therefore higher risk investors would not be rewarded for the extra risk that they take on, and for us it makes no sense to produce a higher risk portfolio when the objective of income can be achieved for less risk. The method of portfolio construction is very similar to the growth portfolios. The primary difference is that the Select 100 funds are screened to see which are the best at producing natural income are.

For the income portfolio we will only conduct a portfolio review once a year in September, rather than twice a year in March and September. The reason is to ensure that the target level of income is reached. If it was reviewed more than once a year it is possible that several final dividend payments from funds would be missed and the portfolio would miss its yield target.

All select investment portfolios are created using optimisation technology based around the diversification ratio, which measures how much risk is offset through the combination of different funds.

Unless all the funds in the portfolio are perfectly correlated to each other, there will always be some diversification effect that ensures the actual portfolio is less volatile than this. The greater the diversification ratio, the greater the difference between the volatility level of the portfolio and its constituent parts. Even when using select 100 funds, there are 17 trillion possible 10-fund portfolios.

This is where the technology is designed to find a shortcut to the one that is most suitable and offers the maximum amount of diversification.

Portfolio Construction

Once the optimiser has identified the most diverse portfolio for each risk level, additional scenario analysis is conducted to ensure the portfolio behaves as it should in a wide variety of market conditions. When finalised, the portfolio composition is reviewed and approved by the investment committee and submitted to the database.

The FE database is run independently of FE Research and once submitted, the portfolios cannot be amended. This ensures that the published data on performance is a fair and accurate reflection of the portfolio-construction process.

Portfolio Reviews

A review of each portfolio is conducted every six months in line with that of the FE Select 100. The purpose of this is to ensure the portfolios stick to their volatility targets and incorporate any changes in the constraints that are deemed necessary, either due to our own analysis or changes in suggested asset mixes.

Funds that have been removed from the Select 100 during the review of the short-list will also need to be replaced. There are charges associated with changing funds in a portfolio, therefore a cost-benefit analysis is carried out to determine how many funds should be added or removed at each review.

The results are compared to what is theoretically the optimal portfolio, in which there are no fund-switching restrictions and the optimiser is able to build the portfolios from scratch. After the two portfolios are analysed, if the minimum switching portfolio is considered significantly sub-optimal compared with the maximum switching portfolio, it will be re-run with the switching constraints relaxed to include one additional fund change, and the comparison process repeated.

This cost benefit analysis is repeated until the portfolio is optimised for the fewest number of possible fund changes.

Portfolio Rebalancing

Our portfolio models are rebalanced quarterly, between each six- monthly portfolio review.

The price of units and the income from them can fall as well as rise. The value of this investment is not guaranteed and on encashment you may not get back the full amount invested. Past performance is no guarantee to future performance. 

“Paul is very approachable and always gives me thorough explanations to my investments.”
Lorraine, Brighton, East Sussex

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