Portfolio construction requires process and discipline: HLB Mann Judd Sydney

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 Trustees of self managed superannuation funds and investors generally need to adopt a disciplined investment process and not construct portfolios haphazardly or based on personal biases and emotion, with no real thought to the risk in their portfolios, says Chris Hogan, wealth management adviser at HLB Mann Judd Sydney.

Chris Hogan

“Portfolio diversification is key. Every portfolio needs appropriate diversification to reduce volatility and asset specific risk,” Mr Hogan says.

“We know of investors holding predominantly residential property or bank shares in their portfolios. This often is based on a firm belief that these assets will always perform well, but this is not the case. The price paid for an investment matters, the lower the better, and is a key determinant of expected future returns.

“It is hard to make a case for Sydney residential property as an investment at the moment given the high prices properties are exchanging for and hence the low net rental yields. Reports that trustees of self managed superannuation funds are investing all their funds in one such property, and possibly with borrowings, further increasing the risk, are worrying.

“The banks have had a golden run and likely still represent reasonable value but bank shares still carry inherent risks. Buying today will not produce returns as good as if the same shares were purchased a year ago. While an investor with a disciplined investment process constructing a portfolio today will likely have exposure to the banks, it should be an appropriate allocation based on their relative value compared to other available assets,” Mr Hogan says.

He notes that stock selection can be outsourced to a fund manager, which is likely to have a lower allocation to the banks compared to many DIY investors.

“Outsourcing to fund managers allows the investor to primarily focus on allocations between assets classes rather than individual security selection,” Mr Hogan says.

A sound investment process will result in the appropriate amount of risk in the portfolio for the investor based on personal factors such as investment time horizon, goals and tolerance to risk. Whether the portfolio is in the accumulation or draw down phase is also important here.

“Risk in this context concerns the split between risky assets such as shares and secure assets such as investment grade bonds, term deposits and cash,” Mr Hogan says.

“The resulting portfolio should have a properly diversified asset mix, with higher weightings to asset classes representing the greatest relative value at the time. For example if Australian shares look relatively better value than international shares, the weighting to Australian shares should be higher.

“If set up correctly the portfolio should provide an acceptable return given prevailing market conditions and be stable enough to provide ‘sleep at night’ comfort when share markets are falling,” Mr Hogan says.

HLB Mann Judd’s process ensures a portfolio tailored to the client with diversification achieved by investing in a mix of risky and secure assets, in multiple asset classes, in multiple investments or managed funds within each asset class, as well as investing in multiple shares, where direct shares are held.

“Above all, the investment portfolio should be constructed to achieve the investor’s goals.  For example long term deposits (of five years) can provide guaranteed income for future year pension payments for the retiree investor. This same strategy is not suitable for a younger wealth accumulator.

“Once a portfolio is established it is important that discipline is shown. Unfortunately investors can tend to panic and make irrational decisions. This usually occurs at the worst time, once markets have fallen, for example, during the depths of the global financial crisis when massive outflows were experienced by share funds.

“Investors can be gripped by fear and want to sell. But history shows that investors with solid underlying investments who hold on and stay the course will come through the other side in good shape. The investor who panics and either doesn’t have a sound investment process or abandons it usually destroys significant portfolio value.

“Portfolio construction is not a set and forget process. Portfolios should be adjusted gradually over time in response to changing client needs and insights as to where value can be found,” Mr Hogan concludes.

HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and part of the HLB Mann Judd Australasian Association.

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For more information please contact:

Chris Hogan – Phone: 02 9020 4216

7 November 2013