Our Investment Philosophy
Portfolio Risk & Return
Over the last few decades, as financial markets have matured, more investment products and asset classes have been made widely available to retail investors. This has allowed us to construct what we like to refer to as modern portfolios. We believe that additional asset classes or non-traditional assets can be introduced to portfolios to achieve superior risk/return outcomes for our investors. This is achieved by introducing new drivers of return that may not be available through traditional assets such as stocks and bonds.
One example, Direct Property could be viewed as a middle ground between growth assets and defensive assets. Over the long term, property returns are potentially higher than fixed interest, or cash, but less than shares. Rental income is generally a significant component of property returns, which tends to enhance the stability of returns over time.
On this chart, we have mapped out risk on the horizontal axis and return on the vertical axis based on data from over the last 4 years. This allows us to plot where various portfolios lie from a risk & return perspective using a mix of indices and products which are either currently in our portfolio or form part of our approved product list.
Beginning with a traditional 70% growth, 30% defensive portfolio with an even split between Australian & International Shares. The portfolio falls on the right side of the chart below. As I map out additional portfolios that include a fourth asset class, private equity, liquid hedge funds, property & infrastructure. Two things occur, in all cases volatility decreases, particularly when hedge funds and property are included. Secondly, all the portfolios are improved upon from a return perspective meaning in all cases the portfolios are more efficient on a risk/return basis.
A sound representation of the way we construct our investor’s portfolios at Arrow is a portfolio that incorporates all 7 asset classes. The portfolio’s overall risk-return dynamic is significantly improved upon versus the traditional portfolio, generating higher returns from a significantly lower level of risk.
Drawdown Analysis
Another benefit of introducing additional asset classes is the extra sources of return they can provide to an investment portfolio. This will result in assets that perform differently across varying periods and environments, which can help smooth returns for investors.
Liquid hedge funds or alternatives such as gold or cryptocurrency can be included in a portfolio to deliver returns above inflation through methods that are independent of the direction of global markets and economic factors. This may allow these assets to perform well during and produce positive returns across periods of stress or heightened volatility.
On the chart below, I have mapped out the performance of both the traditional portfolio and the modern portfolio as shown on the chart above, through the major Covid-19 correction of 2020.
The traditional portfolio which primarily derives its performance from listed equities drew down 22.46%. While this portfolio’s exposure to bonds held up very well relative to listed equities, the portfolio had no exposure to any asset class which generated positive performance across this period.
In contrast, the modern portfolio declined by 16%, or around 6.5% less, due to exposure to assets that either generated positive returns over this period or held up better than traditional assets. An additional benefit of diversified asset classes is the optionality of having extra levers within a portfolio. This allows active investment managers to rotate capital from assets that may have performed well or are currently expensive towards poorer performers or cheaper assets that may have more attractive longer-term growth prospects.
Ultimately, we continue to believe it remains beneficial to incorporate non-traditional asset classes to further diversify portfolios.
If you’re interested in how our investment committee has added value in the past, I encourage you to review our 2021 Portfolio Reviews.
Disclaimer
The information contained on this website and page has been provided as general advice only. The contents have been prepared without taking account of your personal objectives, financial situation or needs. You should, before you make any decision regarding any information, strategies or products mentioned on this website, consult your own financial advisor to consider whether that is appropriate having regard to your own objectives, financial situation and needs.
