Introduction
We believe in a research-driven approach to investing – one which employs investment strategies that deliver against the desired outcome of our clients. By applying this approach to investing, our clients are more likely to meet their specific goals. We focus on practical, pragmatic investment solutions that reach your long-term objective, because that is what matters.
We also believe that investment discipline is the most effective counterbalance to the behavioural tendencies of investors and that a disciplined investment approach increases the probability of clients meeting their long-term goals. Many investors react poorly at the worst possible times. We endeavour to mitigate these reactions by providing solutions specifically designed to maintain discipline.
Constructing Portfolios
Superior investment performance is not our primary goal, but rather superior performance with less-than-commensurate risk. Above average gains in good times are not proof of a manager’s skill; it takes superior performance in bad times to prove that those good-time gains were earned through skill, not simply the acceptance of above average risk. Thus, rather than merely searching for prospective profits, we place the highest priority on preventing losses. It is our overriding belief that, especially in the opportunistic markets in which we work, if we avoid the losers, the winners will take care of themselves.
Consistency is critical – Oscillating between top-quartile results in good years and bottom-quartile results in bad years is not acceptable to us. It is our belief that a superior record is best built on consistent high comparisons rather than a mix of brilliant successes and dismal failures.
Our Investment beliefs:
Investing is not speculating.
Markets are efficient.
Risk and Return are related.
Diversification can reduce risk without reducing return.
Fees and taxes matter.
Deep research and specialisations can produce above benchmark results.
Client Education can improve returns.
Efficient implementation can reduce costs and improve overall results.
Asset Allocation is one of the most important portfolio construction decisions.
Ongoing review of investment strategy is essential.
Investing is not Speculating
The term ‘speculation’ is in direct contrast with the term investment. Investment refers to the process of preserving capital whilst acquiring satisfactory returns, upon consideration of the risk/return trade off. Investors apply funds in the capitalist countries of the world whereby both labour and capital are allocated in pursuit of the best possible financial outcome. All investors are entitled to their share of the market rate of return on their capital and this is accomplished by exposing capital in expert fashion across the various asset classes and sub asset classes over time. Importantly, the cyclical nature of macro and micro forces upon the various asset classes and sub asset classes means that the expected returns can take long periods of time to emerge. This is normal and efforts to short-cut long-term returns are speculative by definition and usually introduce unnecessary and unrewarded risks into the portfolio. We encourage our clients to take a long-term view of investment markets, construct their portfolio in order to achieve their long-term objectives, and stay the course.
Efficient Markets
The efficient market hypothesis (EMH) asserts that financial markets are ‘informationally efficient’. That is, one cannot consistently achieve returns in excess of average market returns on a risk adjusted basis, given the information available at the time the investment is made. The theory was developed by Eugene Fama in the 1960’s and suggests that prices reflect all publicly available information and that prices instantly change to reflect any new publicly available information.
With the current speed of information technology, and the laws that govern the practice of insider trading, the theory appears even more relevant today. Put simply, it is unlikely that you will receive a reliable ‘hot tip’ from a friend as to the prospects of a stock outlook. This is because there are thousands of investment analysts around the globe whose role it is to study company balance sheets, interview CEOs, investigate industry rumours, and who have instant access to political and macro-economic information on which to make buy/sell decisions. These analysts account for the majority of daily transactions and consequently have a significant and instantaneous effect on the price of a particular stock. Therefore, it is reasonable to accept that what really affects the stock prices tomorrow is only what is unknown to traders today.
Risk and Return are Related
The Capital Asset Pricing Model (CAPM) is used to determine the theoretical rate of return for an asset. William Sharpe, Harry Markowitz and Merton Miller jointly received the Nobel Memorial Prize in Economics for this contribution to the field of financial economics. The theory postulates that, given a diversified portfolio, each additional asset possesses a relative and measurable rate of risk and return. Over the longer term it can be expected that the higher the risk, the higher the return. However, over the short term, risk and return can become disconnected where taking higher risks can sometimes produce lower returns. It is certainly possible to outperform markets, but only by way of taking greater risks. Certain risk factors can be controlled to minimise risk and aid long-term return. Remaining invested over the longer term is a key risk management tool.
Diversification
Diversification is a genuine way of reducing uncertainty without compromising expected returns. Diversification involves spreading your investment amongst asset classes, markets, investment managers and securities in order to reduce risk and the impact that any single one of these can have on your portfolio. Correlation analysis is a mathematical technique applied by expert money managers that requires sophisticated programming to implement on a large scale. Put simply correlation analysis is a method of reducing the effect of extreme fluctuations of a particular stock within a portfolio by combining it with another potentially volatile stock, given each stock’s trigger for gains and losses are different. This produces the same long-term average returns of each stock whilst dramatically reducing the short-term volatility (or risk, as measured by standard deviation). This can be achieved across asset classes and within asset classes.
The following is an example of how this technique applies across asset classes: direct residential property is said to have a low correlation to shares, which means that the two act relatively independently of each other. In other words, when the stock market plunges, the residential property market may or may not follow suit. The two events are relatively unrelated. By combining the two assets within a portfolio you can still achieve the higher returns expected of both asset classes and yet dramatically reduce the risk of holding ‘growth’ type assets. An example of how the technique maybe used within an asset class is as follows: a fund manager may hold a position in an airline company whose stock price would generally drop when fuel prices increase. He may choose to therefore purchase a bio-fuel stock, which would typically increase in price as fuel prices rise. These two stocks are negatively correlated meaning, when one goes up the other goes down. Consequently, the fund manager holds two stocks with very similar long-term growth prospects but has reduced the overall short-term volatility of the portfolio by applying similar holding weights in both stocks. Volatility increases your risk of loss of principal or returns. This risk increases as your time horizon shrinks. Therefore, the goal of the portfolio manager is to reduce the volatility for the investors targeted return and targeted time frame.
Fees and Taxes
Beta is a term used to describe the market average return. Alpha is the term used to describe the amount of return achieved over and above Beta. Essentially, it is the fund manager’s role to best select a portfolio of stocks in which to achieve a better return than the risk adjusted market average (Alpha). This is why you pay fund management fees. Sadly, not all fund managers can consistently achieve Alpha. In fact, more recently, research suggests more than 75% of fund managers have not achieved genuine alpha over the last ten years. Finding a manager who can achieve alpha over and above management fees and tax requires extensive research and often access to international money markets.
As individual fund managers buy and sell stocks, they incur transaction fees, which are debited to the fund’s account balance. They are also required to realise any capital gains that apply to that transaction, which again impacts the returns of the portfolio. These transaction fees and capital gains tax implications can be reduced by as much as 75% through the use of a custodial multi-manager.
Deep Research and Specialisations
Premium Strategic Solutions investment process employs rigorous selection criteria across a global universe encompassing thousands of investment managers, and typically results in the appointment of managers that specialise in a particular asset class or style, rather than managers that try to cover all asset classes. The theory behind this is quite simple – it’s easier to be good at one discipline than at a range of them. When an investment manager is included as part of a portfolio, under the PSS philosophy, he is given what is termed a high conviction mandate. This means that he has the ability to simply focus on what he does best rather than trying to be all things to all people. Under the specialist manager process, other investment managers with their own particular specialisations will be combined to achieve a specialised yet diverse investment portfolio. A correlation analysis of the end portfolio ensures that different managers are not overweight in similar stocks, styles, or sectors. This approach provides superior risk adjusted returns over sustained periods.
Client Education and Investor Behaviour
Why is it that most people do not follow the obligatory rule of investing, that being, to buy low and to sell high? Put simply, it’s usually because of the insidious forces of human psychology. Firstly, no one ever really knows when the market is at its peak and when it is at its trough and the temptation to wait a little longer to make a decision to buy or sell is fuelled by either fear or greed. Secondly, it is human nature to not want to miss out, or to keep up with the Jones’s. When it seems everyone else is making spectacular gains it is difficult to ignore the cries of “get in, or you’ll be left behind”. Of course this is usually the sign of an already overvalued market. Conversely, when everyone is saying “you’d be mad to invest now” this is usually a sign that the market is undervalued. Reacting to human psychology can have a significant impact on the long-term outcomes of an investment strategy.
In a recent study conducted by Dalbar Research Pty Ltd, it was found that the average US investor made a return of 3.2% over the last twenty years, up to 2009. This represents a net return of only 0.4% above inflation over this period. However, the S&P 500 (the weighted average US market index) over the same term returned 8.2% or 5.4% net of inflation. So why is it that the average market return was 8.2% yet the average investor only made 3.2%? Put simply, the 5% differential was lost due to bad timing of transactions by the average investor generally driven by decisions based on fear and greed. This is truly wealth destroying behaviour. To put it into perspective, the cumulative result of $100,000 invested over that twenty years would have seen the average investor finish with $178,000. However, if that same investor had left their $100,000 in the market the entire time, without trying to buy and sell at the right times, they would have arrived at the twenty year mark with $548,000. This affirms significant research conducted on active trading vs buy and hold strategies which suggests that time in the market produces far greater results than timing the market.
We at Premium Strategic Solutions believe that education plays a significant role in adjusting investor behaviour and we believe that an ongoing relationship with regular face to face meetings is vital in achieving one’s long-term investment objectives.
Efficient Implementation
Implementation is a critical part of any investment solution. Even if the best investment strategy and investment managers are selected, there are potentially substantial losses if a portfolio is not implemented efficiently. Our team of investment professionals are dedicated to:
Managing daily cash flows to ensure that asset allocations and manager weights are kept in balance without any unnecessary buying and selling of the underlying assets
Managing transitions that result from strategy changes or significant client activity
Ensuring managers’ activities are consistent with their mandates
Structuring investment vehicles to facilitate efficient outcomes
Ensuring the portfolio is implemented in a tax-efficient manner
Reviewing managers’ back-office arrangements and other aspects that may represent an operational risk
Minimising cash flow and market timing mismatches
Ensuing that portfolios remain fully invested while moving to the new target portfolio
Asset Allocation
Asset allocation is one of the most important decisions to make when it comes to constructing an investment portfolio and one that will have a significant effect over the long-term outcomes of your investment strategy. Whilst there are literally thousands of various investment vehicles available on today’s market, they are all essentially made up of four different asset classes, that being, cash, fixed interest, shares, or property. Note, by investments we mean assets that have a capital value and provide an ongoing income return, ie. not speculative non-income producing holdings such as art, collectables, or jewellery.
Shares and Property are generally considered growth assets whilst cash based investments, such as bonds, term deposits etc, are classed as defensive assets. At Premium Strategic Solutions we go through a process to determine the appropriate mix of assets for an individual before we look at the composition of assets within each asset class. Firstly, we determine what measure of returns are required in order to meet your long-term and short-term financial objectives – the things that are most important to you. We then ask you a number of questions as to ascertain what’s known as your risk profile. This gives us an insight to your risk tolerance and your understanding of investment markets. If your tolerance to risk does not match the returns required to meet your objectives, you may need to adjust your expectations for your future lifestyle or seek further education as to become comfortable with the level of risk that is required in order to reach your goals. Finally, we enquire as to your understanding, attitude and prior experiences with gearing into various asset classes to determine whether or not this strategy is appropriate in achieving the required growth component of each of the ‘growth type’ asset classes.
It is important to note that the reason many people do not reach their financial goals is because they become uncomfortable with their investments and sell down their holdings prematurely. It’s important for us as your adviser to be comfortable that our recommendations pass your ‘sleep at night test’ before we implement any portfolio.
Maintaining your asset allocation is essential in assuring you are comfortable with the asset mix over time. Significant increases in markets can overexpose your asset mix to any further fluctuations in prices which maybe outside of your risk tolerance. Conversely, significant falls in asset prices may see the growth component of your portfolio underexposed and consequently forgo the benefits of re-corrections in markets as the asset price returns to its expected value. Regular portfolio rebalancing and understanding your asset mix over time is an important part of investment management and the overall advice process.
Your lifestyle goals and timeframe
The investment timeframe for you to achieve your lifestyle goals and objectives is one of the main determinants in assessing your mix of assets and in determining the allocation between the different asset classifications (ie defensive or growth assets).
The shorter your timeframe, the more your portfolio should be exposed to defensive assets to reduce volatility. Conversely the longer your timeframe, the more time your portfolio has to recover from volatility and therefore a greater exposure to growth assets maybe acceptable.
Your agreed investment timeframe to achieve your lifestyle goals will be outlined in your Statement of Advice.
Rate of Return Required
In order to achieve your investment and lifestyle goals, some clients are likely to need to achieve a return greater than inflation. Inflation reduces the spending power of your money and not generating a return above inflation may result in you not being able to afford your desired lifestyle. Typically, the higher the rate of return required, the higher the risk you need to be willing to take to achieve your lifestyle goals and objectives.
The average return above inflation that we determine to achieve your goals and objectives will be outlined in your Statement of Advice. However, there will be some years where the actual return will be lower, even negative, and some years higher. Uncertainty in future investment returns means that the actual performance of your portfolio may differ from our straight line financial modelling, and can therefore impact on the short-term financial outcome.
Attitudes and Prior Experiences
There is no point holding a high weighting of an asset class that you are not comfortable with. For example, if daily reporting via print and screen media is likely to keep you awake at night, then a large weighting of an asset class with daily pricing, such as shares, may not be suitable. Furthermore, valuation movements can be multiplied if gearing is used to achieve your long term objectives and in the case of borrowing to purchase shares or managed funds (margin lending), significant downward movement in prices can force liquidation of the asset at a time when it is least desirable to sell. This can have the effect of realising what could have simply been a temporary price adjustment or ‘paper loss’, into an actual loss.
Liquidity Required
Liquidity refers to the degree to which an asset or security can be bought or sold in the market without affecting its price. A liquid asset has some or all of the following features. It generally has a high level of trading activity and can be sold rapidly, with minimal loss of value, any time within market hours. Factors to consider in relation to the liquidity of an asset are the costs associated in the disposal or sale of that asset. For instance, shares can be traded quickly and cheaply using online brokerage services for a small fee, conversely, the disposal of direct property usually involves marketing costs, real estate commissions and in some cases borrowing break costs. It is important to consider investment time frames when allowing for buy/sell costs. Generally, the longer an asset is held the smaller the ratio of buy/sell cost becomes, as a proportion of overall return.
Investor Education
It is difficult to settle on an asset allocation within your portfolio if you have a limited understanding of the underlying investments. A lack of knowledge may induce unwarranted stress and, as discussed in the Client Education segment of this document, can lead to counter-productive investor behaviour significantly eroding wealth and increasing portfolio risk. It is the role of the adviser to clearly articulate investment concepts and characteristics simplifying the myriad of investment decisions and reducing unnecessary worry.
Ongoing Review of Investment Strategy
Regular reviews and rebalancing of your investment strategy is vital to the successful achievement of your long-term objectives. Our passive rebalancing process is supported by a group of external investment management professionals who provide reports and research on investment portfolios.
Your investment portfolio review is done in conjunction with the annual life event assessment conducted as part of the ‘Client for Life’ program. We are committed to ongoing relationships with our clients and to reviewing their plans to ensure they are relevant now and into the future, no matter what life delivers along the way.
