BY JUSTIN URQUHART
STEWART, MARKETING
DIRECTOR, AND
TOM SHERIDAN,
CHIEF EXECUTIVE,
SEVEN INVESTMENT
MANAGEMENT
Investors and their portfolio
managers today have a
huge breadth of choice
when it comes to how they
construct their portfolio,
with passive versus active
being only one of the decisions
made.
Before they get close to
the active versus passive
debate, the client’s wealth/
portfolio manager has to
assess a tolerance for risk,
ask questions about
income/capital needs, tax
position, current assets and
liabilities, projected
expenses and so on. They
also have to juggle the
long-term investment needs
with short-term market
moves, with any fund manager,
when asked directly,
preferring the former to the
latter while client-facing
portfolio managers have to
actively manage both.
In terms of asset allocation,
some are suited to
longer-term investment
horizons, ideally five or
even ten years, focusing a
great deal on risk and volatility
reduction, and these
are the ones that will be a
poor choice for a client
with a very high risk
appetite.
l Playing the lottery
As the table on page 40
demonstrates, asset class
behaviour from one year to
the next is a bit of a lottery.
This table shows the average
annual historical investment
returns for each asset
class over discrete ten-year
periods, and the volatility
of those returns to show
how the different asset
classes behave in relation
to each other.
The way we use all of
this information is to then
construct thousands of
combinations of asset
classes to observe which
produced the best portfolio
INDEX INVESTING ACTIVE AND PASSIVE IN A SINGLE PORTFOLIO
The best of both worlds
The active versus passive debate is one that has taken place many times and will
continue to be discussed for years to come, although what is not as readily discussed is
how the two can be used alongside each other in a single client portfolio
returns for a given level of
risk, measured as volatility.
Taking a look at a typical
balanced strategy, in addition
to knowing the expected
returns we can also
show how probable the
actual results are, and how
that varies over time (see
graph below).
One thing that is easily
noticeable is that the predictability
of the annual
returns goes up as time
goes on; as we have seen
in the recent past, in the
short term anything can
A balanced strategy
Expected annual return
30
25
20
15
10
5
0
Expected average return
and will happen.
Once the long-term and
short-term asset allocation
are agreed, it is time to
populate those asset classes,
regions and manager
styles with appropriate
investments. Selecting the
asset classes and regions
first limits the universe of
instruments to choose
from. In the case of active
managers, the range of
potentially suitable funds
are screened quantitatively
first and only those that get
through that test are then
Expected max return
-5
-10
Expected min return
1
3 5
Time horizon (years)
10 20
Source: Seven Investment Management
“
Many private
investors are more
comfortable with
active funds that are
managed by real
people that they can
communicate with
if need be and who
may outperform
over time
”
JANUARY 2010 [www.portfolio-adviser.com] PORTFOLIO ADVISER
35
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