Your financial planner as your investment coach Part 3:

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Build a robust portfolio for all seasons

Now that an investor has a focus on how to invest, the next step in the investment process is to decide what to invest in.  The choice is vast, but the solution, provided you have an astute adviser at the helm, can be reduced down to an elegantly simple set of risk choices.  The returns that these risks should deliver are captured using institutional quality, low-cost funds that seek to deliver the return of each market risk as effectively as possible (rather than trying to beat the market, which is a futile pursuit according to the evidence).

The first and primary decision is how much to invest in growth assets, such as stocks, and how much to invest in defensive assets, such as high-quality bonds that should offer protection against large stock market falls. The overall mix of investments is known in the industry jargon as ‘asset allocation’.  Your financial planner will help by determining the appropriate asset allocation based on a deep understanding of your situation.

A good financial planner will have a disciplined screening programme that will ensure that each type of investment (asset class) is worthy of its place in the portfolio.  Our Investment Committee holds this responsibility and adopts a framework through which it presents arguments for and against the inclusion of a wide range of asset classes in investment portfolios.

Details of the Investment Committee’s asset class review criteria are provided below:

Criterion 1: Economic rationale for returns

Be clear where the returns are meant to come from.  This comes through a proper understanding of underlying risks.

Criterion 2: Useful data insight

Check that there is sufficient, high-quality and reliable data to understand how an asset class behaves.

Criterion 3: Adequate rewards for the risks taken

Make sure the expected return is worth the extra risk taken on compared with other options.  Extra risk should only be taken on if there is an expectation that one will be compensated for it.

Criterion 4: Contribution at a portfolio level

Look at what the asset class does to the whole portfolio.  Some may be expected to provide protection during poorer markets (e.g. high-quality bonds).  Others may be included as core return drivers (e.g. global stock markets).  Regardless, an asset class’s role should be clear and defined.  Remember that to add something into a portfolio, something must be taken out.

Criterion 5: Robust products to access characteristics through

Make sure there’s a simple, low-cost, liquid way to invest in the asset class.  It becomes more difficult to argue the case for inclusion if the only available products are expensive, hard to access or excessively complex.

Criterion 6: Risk management demands

Think about how hard it is to manage properly over time (monitoring, controls, expertise needed).

Figure 1: Asset class review framework

Source: Albion Strategic Consulting

As the late David Swensen stated:

By understanding and articulating the role played by each asset class, investors avoid making allocations based on the fashion of the day.

The thing to remember is that in investing, there is no single perfect solution to building a portfolio. Success lies in a sensible structure with the long-term attributes of each portfolio building block contributing positively to the overall portfolio, and the recognition that in the short-term, some elements of the portfolio will do well and other elements less so.  This is expected and by design.

With investing, your capital is at risk. Opinions constitute our judgement as of this date and are subject to change without warning.

Important notice: This marketing communication is for information purposes only.  Unless indicated, all views expressed in this document are those of the author(s).  The information in this document does not constitute advice or a recommendation and you should not make any investment decisions on the basis of it.

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