Our Investment Philosophy
A clear and robust investment philosophy, understood and supported by all parties, is essential to a rewarding long-term relationship. It is this philosophy that will frame our decisions and manage our expectations.
Our starting point is that trying to beat the market is a fool’s game; far better instead to work with the market by understanding how it functions and using that understanding to enhance outcomes.
We take the view that:
- Markets are efficient price setters
- Fairly priced assets can have different rates of expected return
- Market participants are not rational
- Diversification is key to efficient investing
- Passive investments are likely to deliver better outcomes than actively managed funds
- We never stop learning
Markets are efficient price setters
The combined opinion of the very large number of market participants is overwhelmingly likely to be more consistently accurate than an individual stock-picker (cf. the law of large numbers). Accepting this fundamental means we do not need to spend time and money searching out illusionary ‘opportunities’ and can instead concentrate on strategies that are more likely to deliver appropriate outcomes.
Fairly priced assets can have different rates of expected return
Current asset prices capture a combination of expected future cashflows and the degree of certainty around these. This implies that even if the market has fairly valued two assets the expected returns can be different. In equity markets we use four factors that reflect these differences in returns to influence our portfolio construction:
- Markets tend to outperform cash
- Smaller companies tend to outperform larger companies
- Value stocks tend outperform growth stocks
- More profitable companies tend to out-perform less profitable ones.
Market participants are not rational
Behavioural economics recognises psychological traits that affect investor (and, by extension, market) behaviours that appear to contradict the hypothesis that markets are efficient price setters. However, profiting from these observations is not easy and theoretical gains are typically reversed when trading costs are factored in.
An exception is technical (or trend) analysis, which seeks to benefit from the observations that market participants are inclined to delay decisions and tend to be drawn towards strongly moving asset prices, which together create a momentum effect that leads to trends. Used sparingly, technical analysis can reduce volatility and maximum drawdowns but runs the risk of being out of the market during a rapid recovery.
Otherwise, we use behavioural insights to manage our own behaviour. An important aspect of a robust investment philosophy and a process that includes collegiate decision-making is that they reduce the opportunity for any one of us to follow the herd, become over-confident or take increased risks to recover losses.
Diversification is key to efficient investing
Efficient investing means securing the best risk-adjusted return. We manage risk by diversification within markets and across asset types. We target risk by analysing past data to help the construction of efficient portfolios. We then monitor achieved risk to ensure it does not stray too far from our target. We call this a managed beta approach – beta being a measure of volatility or risk. Passive investments are likely to deliver better outcomes than actively managed funds We generally use low cost passive funds to access close to market-average returns. This is based on research that suggests most actively managed funds will struggle to consistently outperform their index – and that it is nigh on impossible to identify in advance the few that may. We will consider actively managed funds where we feel they deliver diversification benefits at a reasonable price and that we could not easily achieve using passive funds.
We never stop learning
Ongoing research is essential to continue to challenge and refine our assumptions. Just as our approach has evolved over the last two decades so it will continue to do so going forward.