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The road map to success

by Stephen Nguyen, CFA

Defining success is not straight forward, achieving it is even more difficult, so it is imperative to have a detailed and thorough plan. Success might be reaching your savings goals of buying a house, funding your children’s education or retiring at a certain age. The journey may be long or short depending on the nature of the goal, but one’s experience of that journey is of great importance. Research shows that the smoother the journey, the more likely one will see it through and there is nothing more damaging to achieving one’s financial goals than giving up halfway through the journey.

In order to achieve your goals, first and foremost they need to be clearly defined and appropriately aligned. Traditionally, the investment management industry has tended to focus more on benchmarks than on client objectives. This can result in mismatches between clients’ needs and the outcomes they experience.  The conventional balanced benchmark was the popular 60/40 benchmark (a combination of 60% equities and 40% bonds). This is not a bad starting point and has worked well through the great bull market in bonds. However, given where markets are today, with the US equity market currently sitting at an all-time high and sovereign bond yields hovering near zero, and in many instances negative, it is questionable whether this simple portfolio design can deliver sufficient returns for investors in the future. At today’s historically low yield levels, bonds offer significantly less protection and diversification benefit compared to the past. In this new low rate environment, the traditional ‘balanced’ portfolio may no longer be balanced. Investors need to look outside the box for additional tools and search beyond traditional investments in area such as alternatives, credit, convertibles, real assets and precious metals.

A simple balanced portfolio is likely to face return and diversification headwinds as mentioned above, so we think the better approach is to have a carefully constructed strategic asset allocation (SAA), investing in a wide range of asset classes, designed to meet clients’ specific outcomes. The focus should be on outcomes rather than benchmarks. Clients need more meaningful and detailed outcomes aligned to their needs.

We spend a lot of time deriving the optimal SAA for our clients. Our optimisation is multi-faceted and goes beyond simply maximising returns for a given amount of risk.  We include a wider range of asset classes in our SAA’s to increase the naturally occurring diversification benefits.  We consider how those asset classes behave in combination with one another. We assess not only the probability of achieving the return target over the investor’s time horizon, but also the extent of any shortfall versus this target in the majority of adverse scenarios. We then look at the likely range of returns over shorter time periods, such as 12 months. We pay attention not only to the outcomes but also to the path of returns.

Based on these optimisation metrics, we then generate thousands, sometimes millions, of possible portfolio combinations, by varying the weights of one asset class over another. Unfortunately, there is no simple equation which tells us which portfolio will deliver the best outcomes on our key optimisation metrics, so instead we combine the team’s years of experience with the help of our quantitative calculations to arrive at the optimal SAA. 

Rather than a simple conventional ‘balanced’ approach of holding an allocation between equities and bonds, the extensive work and output of our SAA process allows us to have more sophisticated tools and a better starting point to begin the journey with our clients.