Over the last decade, we have been constructing investment portfolios for clients with asset allocation and diversification as the main drivers of our approach.
In 1952, Harry Markowtitz published his research titled ‘Portfolio Selection’ in The Journal of Finance. This research, together with later work carried out by other economists, formed the basis of what has become known as ‘Modern Portfolio Theory’. Subsequent research by Roger Ibbotson and Paul Kaplan concluded that asset allocation accounted for 90% of the variability of a fund’s return over time. Portfolio diversification further reduces volatility, and this is adequately demonstrated through additional research, culminating in the ‘Efficient Frontier’ methodology, evidenced by Markowitz and William Sharpe. These two economists were subsequently awarded the Nobel Prize for Economics in 1990.
We are confident that the approach that we have taken to our asset management over the years has served our clients well. However, as market volatility has continued to increase, we have sought a more consistent approach to the management of our clients’ assets. After extensive due diligence, and in conjunction with several leading investment fund houses, we have created a bespoke Investment Proposition for our clients.
In June 2010, we launched our model portfolios. The portfolios were designed to enhance our existing proposition by further reducing volatility, and to provide clients with a consistent approach to fund selection. Asset allocation and diversification continue to be central to our approach. It has been said that ‘it is better to be in the worst-performing stock in the best-performing sector than in the best-performing stock in the worst-performing sector’. We concur with that view.
Investment Management Styles
Investment funds can be grouped into two general categories when describing their management styles: passive and active.
Passive managers buy and hold portfolios that are designed to replicate the market, and by buying each stock in an index, or a broad representation of stocks, the managers generally deliver returns that match that index. Passive managers argue that markets are efficient, and that there is little room to take advantage of mispricing because prices already reflect true value. The costs of passive management are low because the fund is not being ‘actively managed’.
Active managers seek to build portfolios that outperform a market benchmark, usually through stock selection and market timing. Active managers argue that the market is not efficient, and aim to take advantage of these anomalies and add alpha. Alpha is the excess return of the fund relative to the return of the benchmark index.
After extensive research, we decided on a blend of passive and active funds. The ‘core’ of the portfolio was outsourced to an institutional fund manager on a passive basis.
The ‘core’ was established at 75%, and the remaining 25% was allocated to an actively managed ‘satellite’ portfolio, which was designed to provide further diversification and the potential for enhanced capital growth. The combined ‘core/satellite’ approach was designed to provide cost-effective returns and keep volatility to a minimum.
Risk profiling is integral to the investment process, and it plays an essential part in ensuring the suitability of investments for clients. All clients are required to complete our risk profiler, and this allows us to match a client to the appropriate portfolio.
In simple terms, a client’s attitude to investment risk generally falls into one of three categories:
“I am fairly prudent by nature. I therefore prefer the security of lower-risk investments. The majority of my portfolio should be invested for security of capital. I am willing to accept, however, limited exposure to equity-based investments and I am prepared to accept a degree of fluctuation in the value of my capital, in exchange for improved medium to long-term returns.”
“I regard myself as a balanced investor. A large proportion of my portfolio should contain investments which are for security of capital and/or access to capital. For medium-term to long-term investments, I am willing to accept that a proportion of my portfolio needs to be invested in equity-based investments. I am, therefore, prepared to accept a degree of fluctuation in the value of my capital, in return for the potential for good medium to long-term returns.”
“I am prepared to accept a higher than average degree of risk within my portfolio in the hope of achieving well above average long-term returns. I accept that this strategy requires a high degree of exposure to equity-based investments and I understand that the performance of such investments may be volatile from time to time.”
We created a model portfolio to match these three categories, and the performance of the portfolios have been closely monitored since inception.
Our investment committee meets every six months to review the performance of the portfolios, and make changes if necessary. All research is held on our Investment Proposition library, with any recommended changes documented and minuted.
For past performance statistics please refer to the Performance Tables section.
Our model portfolios are not appropriate for all clients, and so we also manage a range of individual bespoke portfolios. The same principles are adopted, namely diversification through asset allocation, and reducing volatility.