Advisors spend a lot of time and effort building customized portfolios to achieve each client’s needs and goals. But the most perfectly designed mix of assets can’t produce sustained long-term returns without risk management.

That’s why risk management is the essential next step after portfolio construction. Once clients have an appropriate mix of investments, it’s crucial that advisors remain vigilant and protect investors against the effects of market fluctuations and unforeseen economic events.

For advisors, mastering risk management is not just a competitive advantage. It’s a necessity to ensure portfolio sustainability — and it starts with tried-and-true strategies such as diversification, asset allocation adjustments, and dynamic management.

Three proven strategies

Diversification reduces exposure to risk by holding assets that aren’t well correlated, so they tend not to move in sync. Of course, there are many ways to slice and dice the markets, including by asset class (stocks, bonds, and cash), industry, sector, geographic region, company size, and investment style. Portfolio construction tools and all-in-one investment solutions comprising best-in-class funds can help ensure every client’s portfolio is optimally diversified.

Keep in mind that diversification minimizes another type of risk as well. By giving investors a smoother ride, it reduces the possibility clients will diminish their own returns with behavioural investing mistakes. For example, if diversification softens the impact of a sudden stock market dip, clients will be less likely to respond to the emotional pressure to sell at the worst possible time.

Furthermore, diversification has the potential to improve returns. An investor who held only guaranteed investment certificates (GICs) at the average five-year rate for the 20 years ending on December 31, 2023, would have just barely kept pace with the Bank of Canada inflation rate. Diversifying by holding equities as well would have enabled that investor to do better than break even.

Asset allocation adjustments are critical to keep a portfolio aligned to a client’s objectives and risk tolerance. As uncorrelated assets shift, a portfolio can skew away from optimal diversification. Rebalancing must include careful analysis of what to sell, including the tax consequences associated with selling assets in non-registered accounts. In addition, when adjusting the asset allocation of a portfolio, advisors must ensure they maintain risk levels that are acceptable to the client.

While many financial professionals recommend that portfolios be assessed at least once a year, rebalancing may be necessary more frequently than that. Software can be helpful in flagging deviations that may prompt asset allocation adjustments, and rebalancing is built into all-in-one portfolios that are purpose-built for different client profiles.

Dynamic management actively oversees a client’s individual investment positions to determine their exposure to changing market conditions. This is the most labour-intensive part of risk management, requiring ongoing monitoring of everything from market developments, economic news, and industry trends to company-specific events that affect holdings within a portfolio.

It’s difficult for individual advisors to accomplish dynamic management simply because there are only so many hours in the day, and most advisors prefer to spend as many of those hours as possible face-to-face with their clients.

Your trusted partner

Fortunately, advisors don’t have to do any of this on their own. Beneva equips advisors with risk management tools, including detailed investment product analysis, economic reports, risk simulations, and risk management guides. In addition, the firm offers ongoing education through webinars to enhance advisor expertise.

Its investor profile tool leads directly to recommended asset allocations with appropriate risk levels. Meanwhile, its investment portfolio options provide advisors and their clients with choices about how to invest: self-directed selection of individual funds; delegated management through balanced funds managed by a single firm; or turnkey solutions, fund-of-funds solutions.

Supported by the right tools, as well as product solutions that incorporate industry-leading risk management strategies, advisors can tailor their investment recommendations and risk management measures to each client’s requirements. At the same time, they can ensure they’re delivering guidance that conforms to industry best practices. This, in turn, boosts an advisor’s credibility in clients’ eyes — and a trusted relationship tends to be a longer-lasting one that also generates referrals.

Perhaps more importantly, implementing effective risk management adds tremendous value for clients by making it more likely clients will be able to meet their objectives — the ultimate goal of all financial planning work. And finding efficient ways to accomplish risk management responsibilities benefits clients as well. After all, spending less time watching for developments that may affect clients’ investment holdings frees up more time for conversations with clients that facilitate a deeper understanding of their hopes, dreams, and priorities.

In the end, embracing the “must-have” skill of risk management elevates advisors’ guidance to clients and relationships with clients — a win-win for every financial planning practice. Contact Beneva for risk management insights and support.

Here’s why you should integrate ESG criteria into your investment selection process — and how to do it.

Today, ESG is mainstream among institutional investors. In fact, To points out that almost every Canadian is already an ESG investor because the Canada Pension Plan applies ESG analysis to all of its investments. It’s also so core to the operations of large businesses that about three in four S&P 500 companies tie executive compensation to ESG performance.

Furthermore, it’s increasingly recognized that demand for renewable energy is being driven by the private sector — for example, by technology companies that want to move away from fossil fuels —rather than government incentives. To says this “sustainable appetite” stands to benefit ESG investors and the advisors who guide them toward appropriate investments.

ESG screening helps to mitigate risk

While attracting clients and uncovering investments with attractive long-term growth potential may be the flashy side of ESG integration, risk mitigation through ESG investing is probably even more important to build a practice that is successful over the long term. 

As a case in point, in 2022, one of the largest U.S. natural gas and electric utilities agreed to pay more than US$55 million to escape criminal prosecution for two disastrous California wildfires because its power lines were implicated in the blazes. 

“If you had ESG baked into your approach, then this is a company that may have been screened out because of these unsafe power lines,” To suggests, emphasizing that the US$55 million was a drag on the company’s performance and therefore investors’ returns. 

In general, companies that take ESG seriously tend to be more transparent with their investors, he adds, often disclosing more details about their operations than what’s strictly required from public companies. More information helps investors mitigate risk and gives them greater confidence in investment decisions.

Of course, not everyone is equally transparent. Greenwashing — when a company or fund manager pretends to be greener than it is — still happens. For example, a German asset management company recently paid US$25 million to settle U.S. Securities and Exchange Commission charges stemming, in large part, from misstatements concerning the firm’s ESG investment process. Again, a significant cost to the company diminishes investors’ returns.

“It’s important to address greenwashing [and] to ensure there are standards and disclosure requirements for fund managers,” says To.

Design investment policies around client priorities

Integrating ESG into your practice starts with client conversations. 

As part of the discovery process, To says advisors can probe to find out if investing in environmentally friendly companies or companies that have fair labour practices connects with a client’s values. Then, in ongoing client meetings and through financial literacy workshops, they can introduce ESG concepts, aided by illustrations like the ones available through Visual Capitalist.

“Having an earnest conversation with clients is the first step. If ESG values are important, then you can move to the next step and start screening managers for their ESG adherence,” he says.

ESG investors generally expect two things from ESG investments: a social impact and a financial impact.  

To measure the social impact, advisors can check a fund’s holdings against ESG ratings set by MSCI, S&P, and Sustainalytics, which scour the web for corporate data and other information — such as news articles — about a company. It’s a good signal when the vast majority of the fund’s holdings rate highly. 

To measure the financial impact — in other words, the effect on returns — advisors can measure a fund against a benchmark. ESG screening of a fund’s holdings should have a material impact on financial performance against a peer group. Ideally, it will also help to diversify a client’s portfolio. 

Now you’re ready to match specific funds to a client’s investment policy statement, and then clearly communicate social and financial results through customized ESG reports. 

“A best-in-class SRI policy [which considers financial returns and ESG benefits] goes beyond the surface-level aspects of ESG and strives to create a meaningful and measurable impact on society,” says To. “It’s important for advisors to really go into the weeds with clients. Being specific on what they want to accomplish is key.”