“Investing money is the process of committing resources in a strategic way to accomplish a specific objective.”
― Alan Gotthardt
I am often found locked away in a room, spending most of my life looking at spreadsheets, and talking to fund managers. About 70% of my time is spent working on the investment strategies.
In the last blog we explored why we do what we do. We concluded that it is vital to retain this part of the process, that this is what we are paid for and we should devote our time and energy to it.
With this blog we want to share how we have built the process and why everything we do focuses on that.
Do you need a process?
I am of the age where if you wanted to get somewhere you needed to use a map. Before you left, you sat down and planned your journey. You could wing it, but the chances of getting there easily were often more luck than judgement.
My belief is that if you put the time in to something then you are more likely to get it right. In the last blog we explained that in the past, financial advisers sold a product and picked a fund, and then had nothing else to do with the client.
In the short term that might work but how are those clients’ funds doing now?
When I first started in 2011, I had a basic process to work from. Over time this has developed, and even today we are adjusting and refining it. It will never stand still but the principles remain.
We would argue that you need a process because when anything is uncertain you return to ‘first principles’.
What is our process?
We have our portfolios which are freely available on the website. Within that, we have a range of funds that we use. Each year we review the funds and may make changes. In our final blog we will expand on this.
The reality is that we work on the portfolios year-round, and we analyse returns monthly. We look at individual funds and compare performance since January each year, as well as over three and five years.
We are looking for patterns; are funds underperforming and if they are, why? Funds can underperform for many reasons, but red flags could be issues like fund size i.e. has it become too big, or has there been a change of management? Our research will investigate this.
At the same time, we challenge what we are doing and what funds we have. We have had some in the portfolios since we set up them up in 2011, and it is easy to become complacent. We are mindful of this.
Do we really need to spend so much time on this?
In short, yes. We are aware of managers who run portfolios and they actively change holdings as much as once a quarter (sometimes more often). On the other side there are others who pick funds and just leave them and do nothing. We sit somewhere between the two.
If you are actively looking to change every three months, then it means you are making a short-term decision on something. Does this really add value? If we look at performance of certain sectors, some will do better from year to year. If we could guess which ones would perform best, we’d have them all in the portfolio and we’d all be very wealthy – but it doesn’t work like that.
If however, one selects funds and then does nothing with them, it can mean that the risk shifts. As an example, you have 20% UK, 20% US and 60% Global; over time those proportions will drift due to variations in performance.
Our view is that you need to find a middle ground. For us, this means realigning the portfolios with their proper proportions annually. If we don’t change any funds, then the portfolio will still be rebalanced so that the weightings between funds are the same as the previous year.
The other aspect is that we don’t know what will do well from year to year and we don’t make those calls. What we want to find are those managers who can deliver consistent long-term performance. You can only do that by going out and meeting people, talking to them and maybe uncovering gems.
Not all gems are added to the portfolio. If for example, we had researched Neil Woodford’s funds and initially thought they were good, we would still have had an issue with single manager risk. The fund didn’t meet our criteria because of that, so we didn’t include it.
In summary, we think the balance is between the two extremes. We do our research; we try to find ‘gems’ and we actively and without emotion rebalance once a year.
How do we know the process works?
There are two measures we have in place; we aim to beat both over the long-term (5 to 10 years). Firstly, we estimate what we think the returns will be over a 5 to 10-year period and that is our target. This is a difficult measure because we don’t think returns will be the same as in the past, it’s likely they will be lower, so we make an estimate which we think is realistic.
The second measure is the argument we will address in the next blog, which is the use of passive or active management. Ultimately, we should be able to beat a portfolio of passive (index) funds otherwise the process is moot. So, we build two portfolios. One is for our clients (active), and the other matches active with passive versions of those funds.
Over the long-term, the portfolios have significantly outperformed the index (which is what you want). But there are times in the short term where this hasn’t worked. Examples include 2011, 2016 and 2018. 2016 is perhaps the most interesting example; the markets dropped for six weeks over January and February 2016 and by the end of June, the portfolios were behind the index. In the second half of the year, the portfolios outperformed the index but not enough to outperform for the whole year. So, when markets are driving ahead, we expect the portfolios to outperform. In more volatile or downward markets, we expect to underperform. But we believe over time we can offer outperformance which demonstrates that active management works on the whole.
To process or not to process that is the question
We believe to get the right outcome you need to have a process. You have a route to follow (your map) which ensures you don’t try go off piste. Research is an important element of this.
We will not always get it right, but to deliver long-term outperformance we need to be right more often than we are wrong.
Do you need an adviser? Maybe/maybe not, but the real question is whether people have the time to do it, and the ability and discipline to stick to a process.
This is what we aim to do – consistently.
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. 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.