Why constructing a portfolio is not just about chasing returns

Investment conversations, whether around the braai, the dinner table, or even with a professional, tend to naturally gravitate toward growth, return and performance.

However, if a portfolio were constructed using a true bottom-up approach, a conversation about returns would arguably be the least important to have between an individual and their advisor.

And certainly, with the explosion of options available to investors over the last two decades, the so-called historical ‘default’ of a 60/40 equities-to-bonds split in a portfolio is simply not that relevant or useful anymore.

Paul Counihan, MD of Wealth and Investments at Fedgroup, says that tax-optimisation aside, there are three big themes in a portfolio: “The first is income, the second is an asset liability matching strategy – what assets must I have now that will then meet those liabilities in time – and the last one is a growth methodology, where one seeks alpha.

“Planning in these needs-driven ‘buckets’ allows advisors to take emotion out of investing, which is a foolproof way of constructing a proper portfolio. These are very, very independent decisions to be made.

“The first thing I ask a client is ‘What income do you need to generate?’. Then you need to reverse engineer it,” says Counihan.

“You say ‘Okay, here are the options that are the most efficient ways in which we can generate income for you. What portion of the money that you have saved do we need to commit to that strategy?”

Then, for the next ‘bucket’, Counihan says the question requires plenty of context around life stage because these savings need to match whatever commitments the investor has over the next two, three, four, five years.

“We cannot run the risk that that million rand, as an example, is not available in five years’ time,” he says.

This, which could be anything from a child’s tertiary education to a planned asset purchase, requires a different investment strategy altogether.

The final ‘bucket’ is the more traditional returns or alpha-focused portion, which can tend to dominate one’s thinking at the expense of the two other critical building blocks.

Even here, Counihan stresses, one needs to take each client’s unique risk tolerance, risk ability and investment horizon into account. But because the other needs are taken care of elsewhere in the portfolio, one can almost be a bit bolder with the choices made here, he adds.

“You can see the traditional growth portfolio is actually, in some ways, now the last thing that you think about in actually constructing someone’s portfolio because you’ve got these different themes and needs in life beyond just growth.”

Rethinking capital preservation

Counihan says typical asset classes and investment products don’t generally suit the needs in that second bucket, plus there’s a tendency to use very generic options for the income one.

“Your options for your preservation bucket and your income bucket have been pretty boring, and they’ve been very linear. Gone are the days of having to use a bank fixed deposit as your option for capital preservation.”

Even the substitute of using income-focused unit trusts is sub-optimal, as selling units to draw down income triggers capital gains tax.

“Fedgroup has successfully carved a strong niche in this non-alpha chasing world,” Counihan says.

It has done this over 35-plus years by capitalising on the emergence of private capital and alternative asset classes. Think securitised debt instruments in energy and agriculture, not crypto or art. These strategies have delivered consistent returns.

To provide stability and predictability in the first two buckets (income and capital preservation), it has a range of endowments, its Secured Investment (a collective investment scheme participation bond), and unit trusts “that provide an investor with that peace of mind”.

Importantly, this stability is not the same as being overly cautious.

“These are all products designed to protect capital,” says Counihan.

“We also have options that allow them to wrap these investments in tax-efficient wrappers or outside of tax-efficient wrappers,” he adds, while cautioning that not every option suits every investor’s circumstance.

But by using this methodology to construct a portfolio, the headline return is arguably no longer that important precisely because you’re ensuring that three separate jobs are being done correctly.

“Instead of a fixation around return, it’s a fixation around the planning aspect, the bucketing, and the segmentation of how an investment delivers on what the client needs in their life. That’s the main thing.”

Brought to you by Fedgroup.

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