The Fox and the Cat is an Aesop fable in which the Fox boasts to the Cat how clever he is at escaping threats. He has formulated hundreds of ways to escape the enemy. The Cat, on the other hand, has just one escape plan. A pack of Hounds attack and the Fox, confused by the many plans in his head, soon meets his demise. The Cat survives because she has focused on the one thing that would ensure her survival – getting out of reach of the Hounds.
If the Cat were an investor she would not be worried about stock picking within asset classes. She would focus on the one thing that ensures her portfolio would have the greatest chance of success – asset allocation.
In the 1986 article Determinants of Portfolio Performance, Brinson et al, demonstrated that the asset allocation decision was responsible for 93.6% of a diversified portfolio’s return pattern over time. Subsequent studies have confirmed this. The asset allocation decision is responsible for around 90% of portfolios movements, while the remaining 10% comes from security selection and market-timing.
If we, like the Cat, concentrate our efforts on getting asset allocation correct, our portfolio has the greatest chance of success.
Likewise, the costs we incur when investing should be reflective of where there is most portfolio movement. Unfortunately, the fee structures of many active managers who are focusing on stock selection and market timing to extract the most from the 10% of portfolio movement cause fees to be misallocated.
A sound investment portfolio for individuals, superannuation funds and institutions should begin with investment goals and objectives within acceptable levels of risk and appropriate asset allocation. It is here that most time and money should be spent.
While Brinson et al acknowledge active managers, in particular bond and cash managers achieve positive contributions to overall portfolio performance, “it seemed to be harder for managers to outperform equity benchmarks”iii. They concluded “extra returns seemed to be unrelated to the level of active management”iv.
ETFs are ideal trading tools for investors who have worked hard on the key 90%, like the Cat, by using their investment goals, objectives and risk tolerances to determine the most appropriate asset allocation. ETFs allow you to access professionally managed portfolios covering a wide range of asset classes via a single trade on the ASX. Rebalancing and monitoring is simple as ETFs are easy to trade in and out of and are fully transparent. The varied range of ETFs allows investors to easily diversify between sectors to reduce exposure to the risks associated with a particular company, sector or region.
ETFs are also cost effective.
Additionally, ETFs that track strategic beta indices are giving investors the potential to outperform traditional market capitalisation ‘beta’ within a low-cost, passive structure.
The Cat must also regularly review her investments in light of her changing goals and risk appetite and must execute effectively to maintain the success of her portfolio. A portfolio of ETFs makes this easy.
If you would like to learn more about Exchange Traded Funds or ETF’s then simply contact us at the Farm Protectors on either 03 5441 8043 or 03 5022 8118