Roadworthy Portfolios

March 2009

Owners of fuel efficient, all purpose vehicles will tell you they really appreciate them when tarsealed roads turns to gravel and the weather turns ugly.

With blue skies and open roads, sedans or sports cars may cruise along as smoothly as sturdier off road 4X4 vehicles, but the real test of roadworthiness occurs when the conditions deteriorate. What’s needed is an all weather, all roads vehicle that doesn’t cost a fortune or wreck the environment.

Structuring an appropriate portfolio involves similar decisions. You need an allocation that can withstand all investment climates, but you also need to be mindful that in spreading your risks you do not have inefficient, high cost, high turnover strategies that generate large tax liabilities.

When markets are firing on all cylinders, as they have done in recent years, more reckless investors tend to overrate their own skills and drive their portfolios into inhospitable terrain for which they are not suited.

These people often taken on uncompensated risk. They place big bets on single asset classes or a handful of stocks, rather than spreading their risks to cushion the ride when the road turns to mud.

Others might diversify, but then mess up their asset mix by adding flash new features (like high yield credit vehicles) that add unnecessary costs or expose themselves to risks that do not carry a reliable reward.

Owning a diversified asset class portfolio is like having an all-weather, all-roads, fuel-efficient vehicle in your garage. Diversification reduces the risk of your investments without necessarily reducing the overall return. When you add discipline and efficient implementation to the mix, you get a structured solution that is both low cost and tax efficient.

The secret of good portfolio design is not picking the right stocks or timing the market correctly, but getting your overall asset allocation right, as this is what determines more than 90% of the return in your portfolio.

The more asset classes you invest in, the more protected you are from the wild swings in markets. By diversifying, you reduce the volatility of your investments without decreasing your total return, as you are washing away the influence of random unforeseen events.

Like expert engineers who can design fuel-efficient vehicles for all conditions, astute financial advisers know how to construct portfolios to maximise return, while minimising uncompensated risk and keeping costs and taxes low, which is the philosophy we adopt at Stewart Group.

There will be rough roads ahead, but with the right investment vehicle, the ride will be a far more comfortable one.