It is very easy to be drawn to the best returning portfolio
Logically by taking greater “risk” we should be rewarded with higher returns. However, in the short term this doesn’t always seem to be the case.
In this blog I want to explore why over the last three years our adventurous portfolios (moderately adventurous and adventurous) have been the weakest, why the balanced portfolio has been the strongest and how this applies across the different portfolios we have.
Getting “rich” slowly
Perhaps one of my most overused phrases but one I come back to time and time again.
Our aim is to grow your money over time so that it can deliver on the goals you have. The idea is that you can leave the money with us and go away for ten years and not think about it. What it does during this time is almost irrelevant as long as the investment at the end of ten years is higher.
Of course, not everyone is the same and some will want more downside protection than others (but with the acceptance that returns might be lower).
How tight do you hold the brakes?
Investing is a bit like riding a bike…
How we control the bike is through the use of gears and brakes and how much we use these depends on the risk we want to take. And it is not just about the gears and brakes there are other things we can use to lessen the risk and avoid things happening (lights, helmet etc).
The same is true for the portfolios. For the Defensive Portfolio we apply the brakes as hard as possible but with some scope to grow. Effectively we build in as much downside protection as possible (about 59%) without compromising upside growth via equity exposure. Even with the equity exposure we are careful not to select investments with too much risk, or if we do balance this against a less risky option.
Gradually as we go up the risk scale to the adventurous portfolio we release the brake further meaning although there is some downside protection it is minimal. Also the investments we use will carry greater risk but we may use some less risky options to protect on the downside.
Effectively it’s about pulling together different elements to get the right mix.
How do we approach this?
Our aim is to identify the best fund managers who can deliver exceptional performance over the long term, without taking extreme risk. For example, we could pick hedge funds which might return 100% plus returns in one year but equally they can return the same negatively in the next and for us that risk is too great.
Through our research we have a list of around 50 funds which we believe contain some of the most talented fund managers in the country. We then use these across the portfolios. There is some commonality between the portfolio holdings but there are equally some funds which only appear in one or two portfolios.
Why are the adventurous portfolios underperforming?
There is no doubt that the last three years have favoured our balanced portfolio; there is a mix of reasons for this. Effectively the downside protection is just enough to help with the market volatility without impacting on the upside via equity exposure.
But there is more to this, and this is perhaps where I go back to the bike reference and the use of extras like helmets, lights etc! There are three main areas where the adventurous portfolios have a higher risk exposure compared to the balanced portfolio; these are US, emerging markets and specialist investments.
Since July this additional exposure has “contributed” an additional negative return of 2.87% to the adventurous portfolio compared to the balanced portfolio.
Exploring this further; it has been our belief that Emerging Markets still offer the best long term performance characteristics due to changing dynamics and demographics, that certain specialist sectors (biotech and agriculture) are drivers for long term growth and that particularly in the US to drive returns moving forward only an active manager will be able to get deliver returns.
Clearly over the last three years this thesis has been tested! Emerging markets have significantly underperformed, this has not only impacted the emerging market funds we have but also a specialist commodity investment and our emerging Europe fund. Active managers in the US particularly recently have suffered more in the market volatility than index tracking funds and specialist sectors have been dragged down by the market volatility.
All of this is either avoided in the balanced portfolio or targeted in a different way which has meant it has been able to outperform.
Are we wrong
Very few people will admit to being wrong! We are not perfect, and there will be funds we remove. There are many reasons for this, it could be the manager has changed or perhaps the strategy no longer works.
The history of the portfolios shows that at some point the stretch downwards will bounce back, we just don’t know when. What we do know is that when this happens the adventurous portfolios benefit the most.
In 2011 the Adventurous Portfolios returned nearly 7% in one month when the markets rebounded compared to 4% to 5% in the lower risk portfolios. Similarly, in 2015 the Adventurous portfolios returned over 5% in one month compared to 3% to 4% in the lower risk portfolios. We also saw when the markets bounced in 2013 the lower risk portfolios return between 8% and 13% whereas the adventurous portfolios return 17% plus.
The point being that over time those prepared to let go of the brake should be rewarded however it will be lumpier and more uncomfortable, and for this reason some investors may consider a lower risk portfolio.
It is very easy to be drawn to the best returning portfolio and certainly being in the balanced portfolio would have been better than the adventurous portfolios over the last three years. However, at the point the markets reverse and we see a bounce then evidence shows this will come through strongest in the adventurous portfolios.
Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.