Alman Partners offers investment advice strategies, engineered to capture specific risk/return characteristics with reliability and transparency. The goal is to provide investors with a series of precisely defined, low-cost building blocks, allowing them to maximise the benefits of asset-class diversification when assembling balanced portfolios.
What Really Matters?
Successful investment comes down to smart portfolio management. Differences in average portfolio returns can be explained by variations in average risk. To help you understand the concept of risk, we’ve broken it down into the following dimensions:
1. Fixed Interest
The dimensions of fixed interest risk are maturity and quality. Low-quality obligations have higher returns than high-quality obligations. To some, the difference is so great that they invest in high-yield strategies. The maturity dimension is somewhat more complicated. Longer-term obligations don’t have reliable higher average returns compared with shorter-term obligations, even though their prices fluctuate more. Generally, investors concerned about return volatility should avoid long-term obligations and seek investment advice from a professional.
The two dimensions explaining differences in average equity returns are related to company size and financial health. Small companies have small market capitalisations, and financially distressed value companies have higher costs of capital than financially healthy companies. When they borrow from a bank, value companies pay higher interest rates. When they issue shares, they receive lower prices.
A firm’s cost of capital is an investor’s expected return. If a company sells off 20% of its share, the investor gets a claim of 20% of the earnings forever. The return received by the investor is a return foregone by the company. It’s hard to believe a share market could behave any differently. What would the world be like if the largest, safest companies offered the highest average returns?
These two dimensions of equity returns appear in all share markets around the world.
The Flaw of Active Management
Not many active managers invest in companies with poor earnings prospects and poor management. Much of the shortfall from active management occurs when a company’s cost of capital has increased or declined recently after its sale or purchase.
Similarly, the relationship between company health and returns causes problems for fund trustees. Expected equity returns tend to be highest when economic prospects look bleak, and lowest when economic prospects look bright. Trustees often move in the opposite direction. When economic prospects worsen, share prices drop and trustees want to reduce their equity commitments. However, they wish to increase equity commitments when economic prospects look bright. This timing lowers average returns.
Asset Allocation: The Essence of Portfolio Management
Asset allocation is the main emphasis of portfolio management. Expected portfolio returns are shaped by how much is invested in shares versus fixed interest. The fixed interest expected return is largely a function of maturity and quality decisions. The share portfolio expected return depends on the proportions invested in international versus domestic shares, in value versus growth shares, and in small capital versus large cap shares.
Once an asset mix is established, investing is less stressful. There is no second-guessing of the manager because a passive fund always provides the return of an asset class within tight tolerances, and no anxiety about market forecasting because the proportion of the portfolio invested in each fund remains fixed.
In summary, logic and empirical evidence overwhelmingly favour an investment approach based on asset class funds.
At Alman Partners, we understand that investing your hard-earned money can be a daunting process. For easy-to-understand investment advice, please contact us to arrange an obligation-free consultation with one of our expert financial officers today.