What to consider when building a model portfolio

10 May 2018
Financial planners with a FAIS (Financial Advisory and Intermediary Services) Category 1 licence have a duty to recommend suitable investment options to each investor on their books. However, with more than 1500 South African unit trust funds registered with the Financial Sector Conduct Authority (FSCA), identifying which funds are viable is a time consuming task, and cuts into valuable client servicing time.

So how can financial planners build a unique portfolio based on the investor’s needs without jeopardizing their client relationship?

According to Kim Johnson, Investment Analyst at Old Mutual Wealth Tailored Fund Portfolios, there is a growing trend of financial planners moving away from traditional fund selection and opting instead for the use of Discretionary Fund Managers (DFMs). “By using a DFM, the adviser removes the advice risk of picking funds, and makes use of a team of investment professionals to create a model portfolio solution aimed at achieving the clients’ specific financial goals. Through this collaboration, the adviser can focus on providing expert investment advice that is best for the client.”

While the use of model portfolios potentially offers financial planners some benefits – such as improved client outcomes, detailed investment reviews, simplified administration and greater ease of administration – it is vital that the performance of the model portfolio is aligned to the client's risk and return objectives. As such, the following considerations need to be taken into account when building a model portfolio.


For a financial planner to feel comfortable that they will successfully deliver on their clients’ return objectives, the DFM selected must be able to demonstrate consistency in delivering on client outcomes. It is advisable for the DFM to have the backing of a strong investment team, or they should be linked to a reputable financial institution with a proven track record.

Johnson adds that “for the model portfolio approach to work effectively, the team also need access to an experienced team of investment specialists that have proven skills and expertise in asset allocation and manager selection.”


The advice and investment process should be aligned. Johnson notes that the same applies with investment strategies, “the primary objective of any financial planner is to keep clients’ money safely invested and to grow capital over time and, as such, every decision made in the investment strategy should be aimed at achieving the best possible outcome for every client. This implies that the DFM should understand how investment risk is measured and managed on behalf of clients.”


When building a model portfolio, controlling costs is imperative as high investment fees may threaten the probability of achieving the client’s return objectives. The cumulative effect on the client’s investment target becomes more material.

“Many DFMs blend multi-asset class funds within their model portfolios. But combining multi-asset retail class funds can be an expensive way to diversify the investment risks through the use of specialist asset class building blocks, a DFM can control the asset allocation and, by design, manage the investment return objective.”

In addition, many retail funds charge an uncapped performance fee. This leads to less certainty around the overall cost of the solution. Model portfolios built using a flat fee structure therefore allow for more certainty and control over the costs of the solution.


To match investment risk to a client objective, control of the asset allocation is key. Balanced funds can vary from high to low equity exposure even within a single unit trust category, with asset managers often making large changes to asset allocations. Balanced retail funds tend to have high investment fees, and often have a performance fee component, in many cases uncapped, leading to high and varied total investment costs.

Johnson advises that “because fund managers are only required to make their holdings available in arrears, this results in the DFM and planner making decisions based on stale information and therefore not being able to make timeous and accurate decisions, if they wish to be actively involved in the process.”


Portfolios are usually linked to a specific, expected real return and a minimum investment period. To create a portfolio, suitable asset classes must be selected, and a long-term strategic asset allocation should be developed.

“Tactical asset allocation may be employed through taking underweight and overweight positions in specific asset classes around their strategic target weights. This way of tactical asset allocation can reduce investment risk and enhance returns if performed skilfully. Only well-resourced DFMs are able to combine fundamental valuation research with economic insights to derive suitable tactical weights for your portfolios in an ever-changing environment”, explains Johnson.

With all the aforementioned considerations to take into account, financial planners are increasingly seeing the benefit of partnering with a skilled DFM in order to enhance their service to clients. When a DFM is focused on ensuring that clients meet their planning objectives, it contributes to the sustainability and attractiveness of the advice practice.