Transcript: Successful portfolios start with realistic expectations
- April 27, 2021 April 26, 2021
Welcome to Soundbites – weekly insights on market trends and investment strategies, brought to you by Investment Executive, and powered by Canada Life.
For today’s soundbites, we discuss portfolio construction with Susan Spence, vice-president and portfolio manager with Portfolio Solutions Group, a division of Canada Life Investment Management. We talk about managing client expectations, protecting against market volatility, and mitigating investor bias. We started by asking about the fundamentals of creating successful portfolios.
Susan Spence (SS): Portfolio construction is critical to delivering on risk-and-return objectives and ultimately helping investors to reach their financial goal. A properly constructed portfolio considers three aspects: diversification, consistent delivery and risk control. Diversification can be implemented in layers by establishing a suitable broad strategic asset mix and then taking a more granular approach within each asset class using distinct building blocks that can act as offsets or positioning levers. Each one needs to consistently deliver on its specific mandate in order for the overall portfolio to succeed. And this speaks to the importance of manager research and oversight. The third principle is incorporating risk controls into the process. There are different ways to think about risk, but one example would be determining a suitable cap on illiquid exposure. This can be achieved by stress testing the liquid portion of the portfolio to understand the implications of market sell-off on the relative size of illiquid holdings.
How she balances risk and return characteristics.
SS: The important thing is to consider the risk-and-return characteristics of asset classes in combination, not just how they behave in isolation. A portfolio’s strategic asset mix should be driven by long-term trends in return and volatility for each asset class, as well as correlations across asset classes. If a new asset class is being considered for addition to an existing portfolio, an important deciding factor should be whether its inclusion would add value on a risk-adjusted basis, relative to the profile of the current mix.
Constructing portfolios in a low-yield environment.
SS: If investors are exposed to a suitable strategic asset mix, then they should be well positioned to meet their long-term objectives, and they shouldn’t focus too much on short-term trends. Once the strategic mix of a portfolio is established, though, incorporating tactical asset allocation into the investment process provides a great tool to help manage through shorter-term market environments such as low yield or lower return expectations. Tactical allocation is achieved by shifting weight among different allocations within the portfolio, within predetermined ranges around that structure that’s provided by the portfolio’s strategic asset mix.
How she protects against market volatility.
SS: The key is to ensure that the portfolios are initially built with well-diversified strategic asset allocations. Having exposure to investments with a variety of return drivers and risk profiles can help to insulate investors from the volatility of capital markets. In the midst of volatile markets, tactical asset allocation is a tool that can be used to help manage shorter-term risks as they emerge. Another great tool is having a disciplined rebalancing methodology in place. This ensures that a portfolio’s asset mix never drifts too far from its intended target and supports the notion of buying low [and] selling high that can help to add value over time.
How she navigates investor bias.
SS: Investors may have style, regional, or asset-class biases that prevent them from achieving effective diversification within a portfolio, potentially creating an unnecessary headwind in their journey toward achieving their financial goals. So, establishing a disciplined approach to portfolio construction and overall portfolio management, and sticking to that discipline helps to manage investor biases. In particular, ensuring that portfolios are truly well diversified, combined with a focus on capital preservation, can go a long way in mitigating against the negative implications of biases.
Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Susan Spence, vice-president and portfolio manager, with Portfolio Solutions Group.
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