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Constructing a portfolio in volatile times

Predictions of market recovery have divided opinions. The range of divergence reinforces the need for a disciplined and strategic approach to wealth management. We look at some of the fundamental elements of successful portfolio construction and adding long term value.

It is not news to anyone that 2020 has seen a turbulent first 5 months. The main themes once thought likely to dominate the year; the US-China trade war, Brexit and the US Presidential election, have paled in significance to the pandemic and its wide reaching impact. With the ever increasing likelihood of a severe global recession, and global financial markets considerably lower than their January and February highs, much focus has been given to the shape of the economic recovery and the recovery in asset prices. 

Despite early market sentiment and the performance of US markets, few economists and investment professionals now talk of a ‘V-shaped’ global recovery. Advocates of the more prolonged ‘U-shape’ are also quickly dwindling. Various analysts, commentators and institutions have scrambled to find new ways to describe the possible shape of a recovery with these varying from a “tick”, a Nike like “swoosh” and a “hockey stick” to name a few. The speed and inconsistency with which these various descriptors and predictions are forthcoming should serve not only as evidence of the bluster often inherent in investment circles but also of the need for an approach towards wealth management in which there can be confidence whatever the market conditions or economic recovery shape may present.

In this insight, we look at what we believe to be some of the fundamentals in approaching portfolio construction and adding long term value. Following asset allocation itself, one of the important elements to consider is in the overall investment approach, i.e. active or passive – within a portfolio, does one try to beat different investment markets or try to extract the market return from different areas? This is a topic that has been well covered by many, including ourselves, over the years. In summarising our view, we find it difficult to contend with the academic research conducted by many fund managers and Nobel laureate economists. This research has demonstrated that over the long term, through bull and bear markets, the overwhelming majority of active managers, the stock pickers, fail to outperform their chosen markets after costs. From this standpoint, we now explore how additional value can be added via professional advice to enhance portfolio construction and longer term returns from a largely market tracking approach.

Getting the asset allocation right

Multi-asset investing and its popularity have come a long way from the practised divisions of fortune found among some of the wealthy of 15th and 16th Century Renaissance Europe. Today the accessibility of a huge array of asset classes, and indices within them, can cloud the vision of where to invest, what indices to track, in what proportions and how to maintain a portfolio in line with attitudes towards risk.

As is often the case in a market downturn, this pandemic has made clear the contrast that can be present between different asset classes and different global regions. The table below shows the differences in the 2020 return for some of the main equity regions, global bonds and inflation-linked gilts.

alt

* Year To Date return is total return to 31.05.2020
Source: Morningstar Advisor Workstation

While making short term portfolio decisions rarely adds value and risks losing sight of the larger picture, what these stark year to date figures do illustrate is that there is significant value in getting asset allocation right. The split between equities, bonds and diversifying assets, and the allocations to different areas within these classes, are far more valuable considerations than attempting to pick fund managers that may outperform the individual markets. We believe that in constructing a portfolio, a disciplined approach with a strategic asset allocation that is able to produce favourable returns over the long term, whatever market conditions may present along the way, is pivotal to meeting long term objectives. This involves getting the proportions right but also adopting an approach to asset allocation that ensures global diversification and that the overall level of risk is suitable.

The right market

Once asset classes and allocations have been considered, an equally important consideration is deciding how to access these markets. The charts below show the 15 year return on £10,000 invested on 1 June 2005 for three of the most commonly used indices for Japanese equities and for US equities.

alt

Source: Morningstar Advisor Workstation

alt

Source: Morningstar Advisor Workstation

alt

Over this period, £10,000 invested in the Nikkei 225 Average Index would have returned £18,774 more than the MSCI Japan, and £10,000 invested in the NASDAQ Composite would have returned £27,504 more than the S&P 500. 

To obtain a globally diverse and multi-asset portfolio tracking various global markets in desired weightings, one could expect to use a wide range of funds. Selecting the right market to track within an asset class is an important element of portfolio construction. To add to the challenge, when adding diversifying assets such as property or ‘alternatives’ to a portfolio, there are the questions of holding real assets or company shares. When bonds and other fixed interest investments are included, consideration must be given to factors such as maturity, duration and quality.

Final thoughts

Having decided to invest, there are a number of judgements that need to be made in constructing a portfolio that allows the investor to ignore the market noise, or what the shape of a recovery may be. The portfolio must meet the investor’s needs and objectives and align with their views and tolerance towards risk. Selecting the right markets to participate in and in the right proportions are just two of the added complexities that are part of this construction process. Addressing these areas when self-managing can be taking a step into the unknown. We provide professional advice and, if appropriate, an investment service to help clients navigate these areas and meet their long term objectives.

If you would like to find out more, please fill out the form below to get in touch.

About the author

Matthew Hodge

+44 (0)20 7556 1353
hodgem@buzzacott.co.uk
LinkedIn

It is not news to anyone that 2020 has seen a turbulent first 5 months. The main themes once thought likely to dominate the year; the US-China trade war, Brexit and the US Presidential election, have paled in significance to the pandemic and its wide reaching impact. With the ever increasing likelihood of a severe global recession, and global financial markets considerably lower than their January and February highs, much focus has been given to the shape of the economic recovery and the recovery in asset prices. 

Despite early market sentiment and the performance of US markets, few economists and investment professionals now talk of a ‘V-shaped’ global recovery. Advocates of the more prolonged ‘U-shape’ are also quickly dwindling. Various analysts, commentators and institutions have scrambled to find new ways to describe the possible shape of a recovery with these varying from a “tick”, a Nike like “swoosh” and a “hockey stick” to name a few. The speed and inconsistency with which these various descriptors and predictions are forthcoming should serve not only as evidence of the bluster often inherent in investment circles but also of the need for an approach towards wealth management in which there can be confidence whatever the market conditions or economic recovery shape may present.

In this insight, we look at what we believe to be some of the fundamentals in approaching portfolio construction and adding long term value. Following asset allocation itself, one of the important elements to consider is in the overall investment approach, i.e. active or passive – within a portfolio, does one try to beat different investment markets or try to extract the market return from different areas? This is a topic that has been well covered by many, including ourselves, over the years. In summarising our view, we find it difficult to contend with the academic research conducted by many fund managers and Nobel laureate economists. This research has demonstrated that over the long term, through bull and bear markets, the overwhelming majority of active managers, the stock pickers, fail to outperform their chosen markets after costs. From this standpoint, we now explore how additional value can be added via professional advice to enhance portfolio construction and longer term returns from a largely market tracking approach.

Getting the asset allocation right

Multi-asset investing and its popularity have come a long way from the practised divisions of fortune found among some of the wealthy of 15th and 16th Century Renaissance Europe. Today the accessibility of a huge array of asset classes, and indices within them, can cloud the vision of where to invest, what indices to track, in what proportions and how to maintain a portfolio in line with attitudes towards risk.

As is often the case in a market downturn, this pandemic has made clear the contrast that can be present between different asset classes and different global regions. The table below shows the differences in the 2020 return for some of the main equity regions, global bonds and inflation-linked gilts.

alt

* Year To Date return is total return to 31.05.2020
Source: Morningstar Advisor Workstation

While making short term portfolio decisions rarely adds value and risks losing sight of the larger picture, what these stark year to date figures do illustrate is that there is significant value in getting asset allocation right. The split between equities, bonds and diversifying assets, and the allocations to different areas within these classes, are far more valuable considerations than attempting to pick fund managers that may outperform the individual markets. We believe that in constructing a portfolio, a disciplined approach with a strategic asset allocation that is able to produce favourable returns over the long term, whatever market conditions may present along the way, is pivotal to meeting long term objectives. This involves getting the proportions right but also adopting an approach to asset allocation that ensures global diversification and that the overall level of risk is suitable.

The right market

Once asset classes and allocations have been considered, an equally important consideration is deciding how to access these markets. The charts below show the 15 year return on £10,000 invested on 1 June 2005 for three of the most commonly used indices for Japanese equities and for US equities.

alt

Source: Morningstar Advisor Workstation

alt

Source: Morningstar Advisor Workstation

alt

Over this period, £10,000 invested in the Nikkei 225 Average Index would have returned £18,774 more than the MSCI Japan, and £10,000 invested in the NASDAQ Composite would have returned £27,504 more than the S&P 500. 

To obtain a globally diverse and multi-asset portfolio tracking various global markets in desired weightings, one could expect to use a wide range of funds. Selecting the right market to track within an asset class is an important element of portfolio construction. To add to the challenge, when adding diversifying assets such as property or ‘alternatives’ to a portfolio, there are the questions of holding real assets or company shares. When bonds and other fixed interest investments are included, consideration must be given to factors such as maturity, duration and quality.

Final thoughts

Having decided to invest, there are a number of judgements that need to be made in constructing a portfolio that allows the investor to ignore the market noise, or what the shape of a recovery may be. The portfolio must meet the investor’s needs and objectives and align with their views and tolerance towards risk. Selecting the right markets to participate in and in the right proportions are just two of the added complexities that are part of this construction process. Addressing these areas when self-managing can be taking a step into the unknown. We provide professional advice and, if appropriate, an investment service to help clients navigate these areas and meet their long term objectives.

If you would like to find out more, please fill out the form below to get in touch.

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