Relative or Absolute Returns?
Aligning risk and return demonstrates there is a clear relationship between the volatility of returns on an asset class (such as equities) and the return achieved over the long term – the more risk one takes, the higher is the expected return. What’s more, increasing diversification by including alternative assets typically reduces the risk of short-term loss.
When your client selects a risk profile and, by implication, a mix of asset classes that they expect to meet their needs, it is important we monitor and report the performance of this mix, or ‘benchmark’, to ensure it is performing as expected. Our goal is to outperform your client’s benchmark, after charges, over a three year time horizon, by actively managing their portfolio. We therefore compare the performance of their portfolio to their benchmark so you can both see whether we are delivering the returns expected. The table below shows how we do this. Note that the benchmark does not include fees, but that the portfolio return does.
Beware the Bear?
Periodic bear markets understandably make some investors wary of equity investment and favour ‘absolute return’ strategies. These strategies aim to achieve returns that are always positive, even over short time periods and typically avoid a link to any benchmark.
However, without a representative benchmark, your client won’t know how much risk is being taken by their manager nor how the returns are being generated. Our commitment is to transparency, to make sure they have a full understanding of the risks and returns associated with their portfolio, and that means our portfolios will always have a benchmark.
If your client is an investor seeking returns that are likely to be positive over the three year time horizon, regardless of equity market movements, we offer a portfolio of cash alternative investments. This is designed to produce materially higher expected returns than bank deposits, after fees, with a low risk of loss over any twelve month period.
This strategy is only suitable for those investors willing to accept an increased level of risk compared to deposits because some investments in the fund carry higher liquidity, credit and regulatory risk.
Markets move through cycles (of unpredictable length) from being undervalued to being overvalued. The benchmark of your client’s portfolio is designed to deliver their desired return over a full market cycle. However, at times of extreme market mispricing (for example, the technology bubble) we will advise your client that it may be appropriate to make a short term tactical change to their benchmark.
So, if equities are expensive, we may advise your client to consider reducing the equity weighting in their benchmark in anticipation of a market correction. This ‘active’ management of their benchmark means they can take advantage of extreme market mispricing to enhance returns and reduce risk.