Portfolio Construction
Our investment philosophy at Product Innovations is a proven one. In fact it is based on a Nobel prize winning methodology and supported by reams of proven academic research. It is the Holy Grail. It is simple. It will revolutionise investment advisers lives and that of their clients if adopted.
It is based on a simple but powerful idea that investment advisors and their clients should focus on financial planning and determining the factors within their control such as cost and asset allocation, rather than those they can't (market returns, for example). Focusing on asset class selection and allocation, the correlations between asset classes, asset class weightings or market proportionality, and tax efficiency increases the chances of meeting your clients long-term objectives.
The principles of portfolio construction
Asset allocation
Research shows that asset allocation (across all major asset classes— including Equities/stocks, both Developed and Emerging markets, Bonds, commercial real estate, commodities, cash, and alternative investments like hedge funds private equity and managed futures is the single most important investment decision. It is the primary driver of long-term returns and short-term volatility, and should be based on the investment objectives and constraints of the investor.
Read more about the research behind asset allocation.
Asset class weightings and Market proportionality
Allocation within the asset classes i.e., within stocks and bonds etc should reflect the chosen benchmark or market’s overall composition. Overweighting or underweighting any given segment is a bet on the unpredictable and is chasing Alpha, we call this "tinkering" and tinkering can lead to losses as well as gains.
Tax efficiency
For taxable accounts, tax efficiency plays a big role in determining portfolio returns, often more important than investment expenses. Over the past 10 years, for example, taxes represented the largest drag on equity fund performance, outstripping expenses and loads.
Index funds, ETFs, and tax-managed funds – all designed to reduce turnover – historically have been more tax-efficient than actively managed funds.
Decision Hierarchy
Building a portfolio to achieve long-term objectives is a methodical process. Product Innovation believes decisions with the greatest impact on long-term returns should come first.
· Asset class selection
· Asset class allocation to a benchmark weighting
· Correlations between asset classes
· Active satellite and index core to the portfolio
· Investment vehicles used
· Rebalance to benchmark
PIL's PHILOSOPHY
Portfolio Construction
PIL believes in a Core satellite approach to investment portfolio
Construction
Asset Class selection:
What are the main asset classes
available and what are their liquidity and risk characteristics
Asset class allocations:
How much to invest in each category of asset class i.e., weightings in stocks, bonds, cash, real estate, commodities and alternatives. We are wanting to access the Beta of the asset class.Correlations between the chosen asset classes:
The less correlated to each other the greater the diversification benefits to the portfolio of bringing together these asset classes in the one portfolio-these benefits are a reduction in overall portfolio risk and stable risk adjusted returns.Asset allocation:
How to divide assets between tax-preferred vehicles, such as onshore wraps (ISA PEPS) Offshore wraps including portfolio bonds Pensions wrappers, and taxable vehicles, based on tax efficiency.Active/Index based Investing :
Whether assets should be actively managed, taking more risk and costing more for the limited potential of outperforming the markets; or passively managed to match performance of a market benchmark and to access the asset class more cost effectively.· Indexing (through quoted indices, index funds, trackers derivatives and ETFs) provides greater predictability of returns relative to market benchmarks, significantly lower expenses, and tax-efficiency.
· Active management can be used in the satellite with indexing of the core portfolio to add value because markets are not 100% efficient. To achieve success, one must choose active managers based on their long-term track record, consistency of their processes, and management fees.