The optimum risk and return balance
Diversity is a hot topic at the moment, and rightly so. It is crucial for many aspects of life, from society to your vegetable intake, and of course it applies to your investments too. In fact it is so important that diversification is a key input at all levels of the investment process here at Kingswood. It allows us to ensure that your portfolio has the optimum balance of risk and return. This allows your portfolio to grow over time whilst also ensuring you can sleep at night.
It is often hard to ignore the deluge of stock tips from well-meaning friends, the media and industry professionals, particularly in periods of extreme volatility like the current economic fallout from Covid-19 where no one really knows what will happen in the next 12 months. That is why it is more important than ever to have a diverse portfolio and to remain rational in your investment decision making. A clear and disciplined long term investment strategy is key in order to avoid falling into behavioural finance traps. Unfortunately, many investors fail to maximise their returns by reacting to market events: purchasing risk assets and chasing performance in rising markets and switching to low risk investments in falling markets when market sentiment is low. This results in underperformance and missed opportunities from trying to time the market, an often costly exercise.
How do we ensure you have a truly diversified portfolio?
From 30,000 Feet (Top Down):
The asset allocation of your portfolio, meaning the top down allocation, involves targeting a blend of equities, fixed income, alternatives and cash. Using capital market analysis we determine the optimum mix of these assets depending on their return characteristics, correlations and historic volatility and we tailor it to your investment goals, time horizon and risk tolerance.
Put simply, this means that if one part of your portfolio is falling or experiencing volatility, the other parts should be more stable or even growing. To add a further layer of diversification, we also look at the geography, sector, market cap (large, mid and smaller companies) and style (growth, value, quality, and momentum) allocations of your portfolio to spread your risk across the individual assets, ensuring your portfolio can withstand a range of market conditions. We also, on occasion, introduce tactical tilts based on our forecasts.
In the recent market correction, healthcare and technology sectors have proven to be defensive and US quality growth stocks are near all-time highs while the FTSE All Share index is still down 17% (at the time of writing) outlining how different industries and geographies can be impacted by the same global pandemic. Within our bond allocations we like to ensure that we pick funds with exposure to a variety of credit qualities, maturities and durations which will impact how the portfolio performs in different economic backdrops.
In the weeds (Bottom Up):
From a bottom up perspective we aim to further diversify within each type of investment by holding different types of equities and bonds with no holding greater than 10% and no exposure to an investment house greater than 20%. This again avoids over correlation and spreads the individual stock risk. We want exposure to some of the top fund management teams in the industry without leaving clients over exposed. It is important they have a strong performance track record, a rigorous and tested investment process that reduces error and bias, and a fair remuneration structure that does not encourage excessive risk taking. We like the managers we invest in to be emotionally aware, able to continue to learn and not to be defensive around mistakes. The type of investment vehicle used can also be diversified, such as, direct equities or bonds, passive ETFs and funds or actively managed funds. The latter come in the form of open-ended and closed-ended vehicles which each have their own benefits.
When combined, the top down and bottom up approach forms of portfolio diversification do not make your portfolio immune to systematic risk (caused for example by geopolitical issues) but it can help to improve your returns relative to your risk profile over time.
Our Integral Approach
Lastly, for us, diversification doesn’t stop at portfolio analysis, it is a key attribute in the investment decision making process at Kingswood, namely in the form of diversity of thought. By having a diverse talent pool of skilled investment professionals with a wide range of experiences, backgrounds, and specialisms, we believe our investment committees consider a wider range of market and investment viewpoints and avoid group think which in turn enables us to create portfolios better suited to our diverse client base. One way in which we do this is by establishing a thematic equity exposure, where we identify key long term global or industry themes and search for an investable way to express these in client portfolios. This includes investments in: artificial intelligence, environmental change, healthcare, technology, infrastructure, clean water, and frontier markets to name a few. We are interested in companies that will not only survive the next downturn but can continue to grow and gain market share regardless of the economic backdrop.
While research and technical analysis are the bedrock of our investment decision making process at Kingswood, we believe constructing bespoke portfolios for our clients can be more of an art than a science. And just like an artist’s palette, a variety of colours are needed to create a perfect hue, or in our case, a uniquely diversified portfolio.
Vice President | Investment Management