“The essence of Investment Management is the management of risks NOT the management of returns”
‘With the typical cautious investment fund having lost over 16.78% of its value in the twelve months ending 31 March 2009, has this fallen within wary investor expectations or has this been an (unpleasant) shock?’
– Benjamin Graham (Warren Buffett’s mentor)
We would add to the above quote that, whilst we whole heartedly agree with Mr Graham, we believe the first and most important step when managing investments is to clearly define the desired level of risk and to ensure that both the trustee and investment manager have the same level of risk in mind!
Investment managers tend to define risk in statistical terms such as Standard Deviation or Value at Risk. Some even define risk as a ‘Tracking Error’ which, put simply, is the level of over or under performance vs. the agreed benchmark. Ask an investor how he quantifies risk and the response will usually have something to do with losing money!
Even when the trustee and investment manager agree on a level of loss as the key measure of risk, how much work has been done to ensure that the portfolio matches up to this risk appetite? Is the level of maximum loss reasonable in only ‘normal’ market conditions, or will it also apply when the world goes very wrong as it has done recently? Even when things are ‘normal’, risk appetite must be reviewed regularly and certainly after any significant events.
To meet (growing) trustee demand for more consistent and less surprising levels of return, we need to go back to basic investment principles. In 1990, Harry Markowitz won a Nobel Prize for his ‘Modern Investment Theory’. In simple terms, the work allowed investment managers to understand and calculate (not guess!) how to mix a range of assets together to deliver the maximum potential return for a given level of risk. This theory has been improved over the years by a number of very bright people and it is a constant surprise that so few investment managers use this approach when designing investment portfolios. Which of us would get into an aeroplane the first time it was due to fly, if it had been designed in ten minutes using a small piece of paper and a bit of guesswork? Not many, yet most trustees allow their investment managers to follow this approach day after day!
Most investor portfolios are comprised of fixed interest (UK Gilts and corporate bonds) UK shares, overseas shares and, occasionally, commercial property, which is a rather constrained mix of assets. If one were to look at investment portfolios run for very wealthy individuals or institutions, where portfolios would also have exposure to private equity, long-short equity, hedge funds, commodities, forestry, and land, why have the very wealthy invested in these assets when most retail investment managers do not? In our view there are three reasons:
- Lack of knowledge amongst retail investment managers – a lack of awareness of the availability of these investments, as well as a lack of ability to understand and assess such investments.
- Most alternative investments are long term in nature and, therefore, reduce the dealing commissions which are so frequent in the retail investment world and are a large part of most investment managers’ remuneration.
- Investor knowledge – most investment managers are not prepared to spend the time educating trustees on the benefits of these alternative investments and take the easy option.
Ever since we launched the Vantis Investment Strategies in 2006, we have ensured that the risks we take within our client portfolios are aligned to the attitude to risk of our investors. In addition, we have diversified our client’s portfolios across a very wide range of asset classes. As a consequence of this, all of our Strategies have delivered significantly better performance than their respective benchmark indices. Not only have we achieved better performance, but we have delivered this with much less risk during what has been a period of unprecedented investment volatility.
Should you wish us to review your existing investment portfolio and provide you with our view, then please contact a member of Vantis’ Charity & Not for Profit Group or Vantis Financial Management. Alternatively, please complete the contact form below.