Discretionary Fund Management Service (DFMS)

1) What is the Discretionary Fund Management Service (DFMS)?

Ans: A service for those investors interested in investing via regular saving plans or lump sum contributions

DFMS helps you manage the large array of funds life insurance companies have made available to you by selecting funds according to your personal profile and objectives

Investment professionals, backed by a competent administration team, set up and regularly monitor your investment structure and the performance of the funds in which you invest.

Your investments will be rebalanced when necessary according to your risk profile and financial objectives. Locking in profits and minimizing downside moves without reacting to emotional biases is the key to success. Few succeed in this demanding function because they lack the resources or time to manage your investments professionally.

2) Why do I need DFMS? There are already managers for the funds in my portfolio?

DFMS rebalances the holdings of your funds based on both individual fund performance as well as a determination of the optimum allocation for your personal needs. Example: a fund manager of a Japan Equity Fund might be doing a great job - but if Japan as a whole were a dangerous market DFMS would not include it in its selection. Most investors choose funds from a large list - their initial choices are often based on:
1. Previous performance
2. Familiarity with a provider
3. Knowledge of certain sectors

More often than not, there are no switches made by investors for years - and any switches that are made are based on emotion, greed, or trying to 'outsmart' the market. By placing fund selection and management decisions in the hands of an objective team of experts, your returns will be enhanced while reducing unnecessary risk wherever possible

3) How does DFMS manage my funds?
The biggest determinant of fund performance is asset allocation - weightings between equities, bonds, cash and alternative investments are key to our strategies. But we do not stop there - we scrutinize each fund regularly based on:
1. Fund manager's style and track record
2. Geographic weightings
3. Currency exposure
4. Fund turnover (how often do the underlying investments change?)
5. Volatility (how risky is the fund?)
6. Performance and risk versus similar funds
7. Costs
8. A database of funds is kept and updated regularly - based on this, personalized portfolios are created and monitored.

4) Is my portfolio actively managed?
Yes. We monitor each portfolio and take the necessary steps to maintain the correct balance.

5) How often does DFMS make changes to my portfolio?
There may be no changes within a three-month period, or there may be one each month, depending on the need. Changes are driven by clients' needs and market movements.

6) Does DFMS change a portfolio's asset allocation depending on market conditions?
Not necessarily. Each asset class is assigned a range within which it may move. We alter the actual percentage - within this range depending on macroeconomic and market conditions and prospects.

History has proven that maintaining a range of weightings within each asset class leads to better long-term returns.

Risk

Ah risk! Everyone seems to be an expert. We all talk about risk, discuss it, we think we own it. In fact our whole lives are bathed in a pool of risk. From the moment we are born (infant mortality rate) to how well we fare during our lives (chances of success) and, ultimately, how long we live, all depends on risk.
One would think that our understanding of risk should be pretty good, maybe even excellent. After all, it seems that in everything we do, risk has a role to play. Yet, sadly, this is not the case. Risk assessment remains a “black” art, to be understood and mastered by few.
So what is risk? Is it maturity versus immaturity, experience versus inexperience, OR even greed versus reason? It’s all of them plus more! One common thread running through these “definitions” is tolerance for the unexpected. And this is the definition that we will stick to.
An immense amount of work has been carried out in order to assess risk. Insurance companies thrive and depend on these types of calculations.

In all different facets of everyday life we as individuals are constantly calculating risk. Most of the time we are not even aware we are doing it – crossing the street, the speed at which we drive, how much we eat and drink (one for the road) etc. It’s all a risk calculation. One thing is certain – each and every individual has a unique way of calculating risk.

However, being a financial publication, we will now concentrate on the financial side of risk. Building on what was discussed above, financial risk is just another risk factor in the myriads that swamp our everyday lives. Come to think of it, it’s not even the most important one since it certainly isn’t life-threatening. Yet, if you ask around, about ones risk profile, the first thing they’ll mention is financial risk. They could be living on a volcano precipice or directly over the San Andreas Fault and yet that’s not what they’ll site first. Amazing! Why though?

Money:
The king to end all Kings, the End to everything, THE goal. So what does this mean to people like us, in the financial community? It means one thing: in order to be successful in the long haul, we have to mitigate risk. Seems perfectly reasonable but alas, this is not always to everyone’s liking. Everyone seems to like the concept, and yet, when it comes to implementation they start to huff and puff: “My returns aren’t high enough” or our old favourite “My friend told me about this fund, it returned 15% in the last little while. My investments aren’t anywhere near those numbers”.

We started by saying that people in general don’t really understand risk. Further, people don’t really understand their own tolerance to risk. Everyone wants to make the maximum returns. Unfortunately not everyone comprehends that the old axiom “Risk versus Reward” holds true at all times. It is practically impossible to make gains that aren’t matched by possible losses of the same magnitude. All of us can confidently state that we would be very happy with a 15%/pa return on our investment. Would we, with the same confidence, say that we would be unfazed by a 15% loss? Some of you might rush to answer positively. However, please, reach deep inside yourselves and answer truthfully. The reality, more often then not, is that you would be furious and blame the financial manager as incompetent. It may very well be the case but it could also simply mean that you and your financial manager took on more risk than you were able to tolerate.
John (Jack) Bogle, one of the greatest investors of all time, even though not the most popular, once said:
“If you have trouble imagining a 20% loss in the markets, then you shouldn’t be in the markets”.
True indeed, if you are aiming for a 20% return.

The other side if the coin is Warren Buffet (no introduction required) whose investment strategy relied on two basic rules:
1. Don’t lose money and
2. Remember rule 1.

Both of these investors have been extremely successful. Which camp do you belong in?
We, as financial advisors, attempt through knowing our clients, to determine and assess their tolerance to risk. This information will allow us to tailor the investment portfolio to be within an acceptable risk envelope for each specific client. It is true that we’d rather err on the side of caution, at the risk of limiting risk and consequently returns. We do believe though that through this strategy, we are doing what’s best for the clients even though they might not immediately appreciate it. But we are confident that in time, they will.
We’d rather be called “too cautious” and “too risk averse” rather than loose money. Maybe that’s just simply not fashionable anymore but we are not in the fashion business!
We don’t mind being classified like that and in the long run you wouldn’t either!

Copyright© Wealth Management Solutions Inc. - January 2005
WHAT ARE YOU BEING SOLD?

Investors’ natural tendency is to want and expect big returns. Investment companies spend billions in advertising to lure prospects on board. They try to dazzle investors with recent impressive returns from funds. It is human nature that makes individual investors chase funds and strategies that have produced the best returns. We emphasize the past tense in “have produced”. There is nothing easier than hindsight to choose the best performing funds of the past and to advertise them.

Sadly, past returns are only a small part of what determine future performance. In equity funds past performance is not a reliable predictor of future results. If a fund does well in one year, it is possibly because its managers took some extra risks to do so, and eventually those risks will bite them and their investors. It can be just as misleading to focus on returns from the recent past, as it is to focus on a high annualized/average return when a “freak” year produced a performance that was much higher than the norm.

Some of the most respected invested professionals in the world have recently predicted negative to single-digit positive growth in almost all asset classes (equities, bonds, commodities, real estate) for 2005. They cited the lack of good values across the board in a world economy that is only growing at nominal rates.

What should you look for in a portfolio structure? We have identified 6 criteria you should be aware of when considering your portfolio manager:

1. Have you been sold on impressive PAST PERFORMANCE of underlying assets? Always question large double-digit gains of the past, as well as how selective these have been. Past performance is often worthless when it comes to trying to figure out the future. The best use of past performance is to determine how a manager behaved in a particular set of prior circumstances. The hold axiom “If it sounds too good to be true, it probably is” holds here.
2. Is it well DIVERSIFIED? Simple concept: spread the risk among different asset classes and while returns will be moderated, so will the downside. Diversification is a complicated process that involves proper evaluation of the investment sectors and determining the degree of potential correlation between them. It also involves determining the appropriate levels of investment in the various sectors as a direct consequence of a number of factors that are evaluated. The investor must insist that their portfolio manager understands proper portfolio strategies including diversification.
3. Do you understand the RISK involved? The manager must have a clear understanding of what the risk is and relate this to the investor in very clear terms, with both upside and downside outcomes. For example, a “balanced” portfolio will contain a balanced spread among asset classes. Private wealth managers such as Merrill Lynch and UBS generally allocate 40-60% in equities in a balanced portfolio. At WMS we tend to allocate less. Investors should not be confused with terms such as “cautious growth”. What does this mean?
4. Is the choice of assets INDEPENDENTLY chosen? Securities and funds must be chosen because the manager truly believes they are the best under the circumstances. It is highly unlikely that one fund family will satisfy most of a portfolio’s needs. We have seen time and again that for modest portfolios (of less than $1M) most portfolio managers tend to allocate a large part of the portfolio to in-house funds. A word of caution: when you spot the majority of your asset being placed in funds by the same company, be worried!
5. What is the COST of the chosen investments? In a low interest-rate/low return environment, portfolio costs should be kept to a minimum. As such, equity funds with high expense ratios should be avoided (funds-of-funds fall in this category). It is also common that small equity funds (with less than $10M under management) have higher expense ratios because some of the fund fees (as a percentage of total assets) are very high.
6. Is COST-AVERAGING being used? The manager must never buy large positions at the same time. In the same way he must never liquidate large positions at the same time. It is a disservice to the investor to make a clean sweep by selling all existing assets of a new portfolio at once, with no regard to prevailing market conditions, and in order to implement his own strategies immediately. It is also often a mistake not to hold enough cash to take advantage of unforeseen opportunities.

In conclusion portfolio management is a complex task that needs to balance good judgment about the future with equally sound risk management. It will be painful to investors if they let their human nature guide them solely in the direction of greed.

To quote from Bloomberg columnist Caroline Baum:
History repeats itself primarily because human nature doesn't change. On Wall Street, human nature is circumscribed by fear and greed. Among investors, fear seems to be a rare commodity these days.