Our Investment Philosophy
Asset Allocation:
Asset allocation is the key factor which drives the performance, both positive and negative, of an investment portfolio. Research shows that upwards of 80% of the price movement of an investment portfolio is down to asset allocation. Less than 4% is due to market timing and securities selection. It follows that an investor’s best opportunity of fulfilling their objectives will come from a proper assessment of asset allocation.
If one looks at historical returns, one can see that there is no pattern as to which asset class is the top performing asset class each year. The top asset class this year may be bottom next year. Hale do not believe that it is possible to reliably forecast which will be next years best performing asset class, or indeed what the returns may be. This belief leads us to reject tactical asset allocation and to focus on strategic asset allocation.
Investors should, and in practice looking at returns over very long periods do, receive a better return for taking more risk. The risk free return for UK investors would be UK treasury bills. One can measure the real inflation adjusted returns for different asset categories over the risk free return.
The research of Markowitz and others conclude that asset diversification can lead to improved risk adjusted returns. By applying the Capital Asset Pricing Model which focuses on the risk premium over the risk free return for a given asset class, one can evaluate the risk adjusted return that might be received over a very long period of time from a given portfolio containing different asset classes in differing proportions.
One can plot graphically what the return might be for differing portfolios with different risk profiles. Such a chart is known as the “efficient frontier”.
For an individual client our approach is as follows:-
- Complete a “finametrica” risk questionnaire so that we can access your attitude to risk
- Complete a comprehensive financial plan so that we can assess what returns you need to achieve your objectives.
- Resolve with you any inconstancies between required returns and the risk profile
- Review the cash requirements, if any, that the portfolio is required to produce and when
- Agree with you the time horizon that there is for the portfolio. This can be variable to meet income or other withdrawals that need to be funded.
- Draw up a strategic asset allocation and agree this with you.
At this point one has to select the individual funds to support the agreed asset allocation. I mentioned earlier that less than 4% of returns were due to market timing and securities selection. In addition there is a body of research that supported the fact that:-
There is no reliable persistency in the performance of active managers. Past performance is really no guide to future performance. Trying to pick who tomorrows top managers is a question of chance and not skill. Active managers have to be paid, they turn over stock more frequently so their costs are appreciably higher than passive managers, or index tracking funds. Active managers need to outperform the index quite significantly to just cover their costs.
Since Hale do not believe active managers can reliably outperform, we build the core, in excess of 80%, of a clients investment portfolio from passive funds. The remaining funds are invested in alternative asset categories which are designed to reduce the risk and volatility of a your portfolio. There is no doubt that if a client really does have a sufficiently long time horizon that equities will outperform these alternatives. Where this is the case we will discuss with you the benefits of retaining a greater percentage of the portfolio in equities.
Research from Fama/French in respect of equity returns has identified that a risk premium over the market return exists for companies defined as value companies as well as smaller companies. The risk premium is highest for small value companies. The result of taking greater risk is that investors are rewarded with higher returns. However value and small companies can underperform the market for several years in a row. Your time horizon is critical in adopting such a strategy, as over longer periods it is more likely that you will be rewarded for taking extra risk. Clients who have the appetite for risk and the necessary time horizon are those that are likely to have higher equity components substituted for hedge funds and alternatives.
Volatility and Risk:
Volatility is regarded by many people as an indicator of risk. Standard Deviation (a description of the way in which statistical data disperse themselves around the average) is a commonly used measure of a fund's volatility. A low standard deviation means that the monthly returns for a given fund show little variation from the mean and that the volatility is relatively low compared to the other funds in its sector. A high figure represents a more volatile performance compared to the other funds in the same sector.
Portfolio construction can help to reduce risk. If funds and asset categories are chosen, which have low correlation with each other, this will reduce risk. These days, US, UK and European stock markets tend to move together. Japan, Pacific and Emerging markets, whilst influenced by these other markets, do not necessarily follow suit. Bond funds behave differently, as does property. By utilizing these different assets categories a portfolio can be designed, which is lower risk than its individual components. Thus a medium risk investor may have some higher risk funds included in their portfolio.
It is the choice of asset categories that matter when managing risk, not the investment vehicle. Investment vehicles such as pension funds, investment bonds and ISAs, are important when planning tax efficiency, access to funds, Inheritance Tax Planning etc. A description of some of the available investment vehicles is appended.
How Hale arrive at an agreed risk profile for you.
Hale use Finametrica as a tool to assist in risk profiling. You will have completed the questionnaire and seen the result. We then discuss the following with you:-
The time horizon for your investments.
Check your tolerance to loss and what return you need to make to meet your objectives.
If your objective is not to maximise your estate for your heirs, but merely that they should enjoy what is left as tax efficiently as possible, then one might argue that the investment return is one which ensures that you do not run out of money. If for example, your investments merely kept pace with inflation and you are forecast not to run out of money, then you could target a lower level of return, with less risk.
The higher the rate of return needed to meet your objectives, the greater the risk has to be in your portfolio. The question arises, what return is required. If your objective is to maximise your estate for you children, then a higher return may be necessary. If on the other hand the objective is for you to enjoy your life and the children get what is left, then it might be possible to adopt a lower investment return and hence reduce risk.
The resulting asset allocation flows from this process. Finametrica analyse investors into 7 risk profiles. There follows an extract from their web site as to how investors who fall into each category might think about investments, risk and reward.
Risk Group 1
Making Financial Decisions
They usually think of "risk" as "danger" and have, at most, little confidence in their ability to make good financial decisions. They usually feel at least somewhat pessimistic about their major financial decisions after they make them. They are prepared to take, at most, a small degree of risk with their financial decisions and are always more concerned about the possible losses than the possible gains.
Financial Disappointments
Typically, when things go wrong financially they adapt very uneasily.
Financial Past
They have taken no more than a small degree of risk with their past financial decisions and have never borrowed money to make an investment.
Investment
Most feel that it is much more important that the money value of their investments does not fall than that it retains its purchasing power. Over ten years, most expect an investment portfolio to earn, on average, not more than about one and a half times the rate from term deposits. Any fall in the total value of their investments would make them feel uncomfortable. Given the seven portfolios, their most common choices are 0/0/100 and 0/30/70 mixes of high, medium and low risk/return investments.
Risk Group 2
Making Financial Decisions
They usually think of "risk" as "danger" or "uncertainty" and have, at most, little confidence in their ability to make good financial decisions. They usually feel at least somewhat pessimistic about their major financial decisions after they make them.
They are prepared to take, at most, a small degree of risk with their financial decisions and are usually, if not always, more concerned about the possible losses than the possible gains.
Financial Disappointments
Typically, when things go wrong financially they adapt somewhat or very uneasily.
Financial Past
They have taken no more than a small degree of risk with their past financial decisions and have never borrowed money to make an investment.
Investment
Most feel that it is at least somewhat more important that the money value of their investments does not fall than that it retains its purchasing power. Over ten years, most expect an investment portfolio to earn, on average, not more than about one and a half times the rate from term deposits. Any fall in the total value of their investments would make them feel uncomfortable. Given the seven portfolios, their most common choice is a 0/30/70 mix of high, medium and low risk/return investments.
Risk Group 3
Making Financial Decisions
They usually think of "risk" as "uncertainty". They have a reasonable amount of confidence in their ability to make good financial decisions and usually feel somewhat optimistic about their major financial decisions after they make them. They are prepared to take a small to medium degree of risk with their financial decisions and are usually more concerned about the possible losses than the possible gains.
Financial Disappointments
Typically, when things go wrong financially they adapt somewhat or very uneasily.
Financial Past
They have taken a small to medium degree of risk with their past financial decisions. Two-thirds of this group have never borrowed money to make an investment.
Investment
With regard to the money value of their investments, they feel that retaining its purchasing power is of comparable importance to its not falling. Over ten years, most expect an investment portfolio to earn, on average, from one and a half to twice the rate from term deposits Typically, they would begin to feel uncomfortable if the total value of their investments went down by 10%. Given the seven portfolios, their most common choice is a 10/40/50 mix of high, medium and low risk/return investments.
Risk Group 4
Making Financial Decisions
They usually think of "risk" as "uncertainty". They have a reasonable amount of confidence in their ability to make good financial decisions and usually feel at least somewhat optimistic about their major financial decisions after they make them. They are prepared to take a medium degree of risk with their financial decisions and are usually, if not always, more concerned about the possible gains than the possible losses.
Financial Disappointments
Typically, when things go wrong financially they adapt at least somewhat easily.
Financial Past
They have taken a small to medium degree of risk with their past financial decisions. Most have never borrowed money to make an investment. The great majority have never invested a large sum in a risky investment mainly for the "thrill" of seeing whether it went up or down in value.
Investment
Most commonly they feel it is somewhat more important that the money value of their investments retains its purchasing power than that it does not fall. Over ten years, most expect an investment portfolio to earn, on average, from one and a half to twice the rate from term deposits. Typically, they would begin to feel uncomfortable if the total value of their investments went down by 20%. Given the seven portfolios, their most common choice is a 30/40/30 mix of high, medium and low risk/return investments.
Risk Group 5
Making Financial Decisions
Most think of "risk" as "opportunity" and have a reasonable amount, if not a great deal, of confidence in their ability to make good financial decisions. They usually feel at least somewhat optimistic about their major financial decisions after they make them. They are prepared to take a medium degree of risk with their financial decisions and are usually, if not always, more concerned about the possible gains than the possible losses.
Financial Disappointments
Typically, when things go wrong financially they adapt at least somewhat easily.
Financial Past
They have taken a medium degree of risk with their past financial decisions. About half have borrowed money to make an investment. Most have never invested a large sum in a risky investment mainly for the "thrill" of seeing whether it went up or down in value.
Investment
Most feel that it is at least somewhat more important that the money value of their investments retains its purchasing power than that it does not fall. Over ten years, most expect an investment portfolio to earn, on average, from two to two and a half times the rate from term deposits. Typically, they would begin to feel uncomfortable if the total value of their investments went down by 20%. Given the seven portfolios, their most common choice is a 50/40/10 mix of high, medium and low risk/return investments. Borrowing If they were borrowing a large sum of money at a time when it was not clear which way interest rates were going to move and when the fixed interest rate was 1% more than the then variable rate, they would choose to have at least 50% of the loan at variable interest.
Risk Group 6
Making Financial Decisions
Most commonly they think of "risk" as "opportunity". They have a great deal of confidence, if not complete confidence, in their ability to make good financial decisions and usually feel very, or at least somewhat, optimistic about their major financial decisions after they make them. They are prepared to take a large degree of risk with their financial decisions and are usually, if not always, more concerned about the possible gains than the possible losses.
Financial Disappointments
Typically, when things go wrong financially they adapt somewhat, if not very, easily.
Financial Past
Most have taken a large degree of risk with their past financial decisions. Most have also borrowed money to make an investment. About half have invested a large sum in a risky investment mainly for the "thrill" of seeing whether it went up or down in value.
Investment
They feel it is much more important that the money value of their investments retains its purchasing power than that it does not fall. Over ten years, they expect an investment portfolio to earn, on average, at least three times the rate from term deposits. Typically, they would begin to feel uncomfortable if the total value of their investments went down by 33%. Given the seven portfolios, their most common choice is a 70/30/0 mix of high, medium and low risk/return investments.
Risk Group 7
Making Financial Decisions
Most commonly they think of "risk" as "opportunity" or "thrill". They have complete confidence, or at least a great deal of confidence, in their ability to make good financial decisions and usually feel very optimistic about their major financial decisions after they make them. Most are prepared to take a very large degree of risk with their financial decisions and are always more concerned about the possible gains than the possible losses.
Financial Disappointments
Typically, when things go wrong financially they adapt very easily.
Financial Past
They have taken a large to very large degree of risk with their past financial decisions. The great majority of this group have borrowed money to make an investment. Three in five have invested a large sum in a risky investment mainly for the "thrill" of seeing whether it went up or down in value, some have done so very frequently.
Investment
Most feel that it is much more important that the money value of their investments retains its purchasing power than that it does not fall.
Over ten years, most expect an investment portfolio to earn, on average, more than three times the rate from term deposits. Typically, they would begin to feel uncomfortable if the total value of their investments went down by 50%. Given the seven portfolios, their most common choice is a 100/0/0 mix of high, medium and low risk/return investments.
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