Investing is the process of delaying consumption from today to sometime in the future and employing that money in the meantime in the markets to grow at a rate at least in line with inflation, but preferably more. The lifestyle goals that you want your money to achieve for you need to be carefully defined. In turn, these lifestyle goals can be translated into financial goals against which your portfolio will hopefully deliver suitable mid- to longer-term returns. It is defining this sense of purpose that sits at the heart of good financial planning and which allows for the construction of a portfolio strategy that you will be able to live with both emotionally and financially. So far, so good.
As the old saying goes, however, investing is simple but not easy. This note summarises what we believe to be a sensible and highly effective way to invest your money. Investing may never be easy, but it can be far easier once you employ a systematic approach, like the one we have designed.

Investing money well requires a logical and robust framework on which to build a lifelong investment programme.  It needs to be grounded in investment theory, supported by empirical evidence and enhanced with an insight into the behavioural traps and pitfalls that all investors face, that can and do cost them dear.

1. Five lifelong principles

We start by looking at five guiding principles that provide the backbone for how we should think about investing, rather than what we should invest in.

Have faith in capitalism and confidence in the markets

Capitalism is an adaptive, robust economic system that has delivered incredible developments to the benefit of mankind.  For example, the wealth creation of capitalism has meant that over the last 25 years, around 2,000,000,000 (two billion) are no longer trapped in crushing poverty and child mortality rates have fallen by over 50%.  Despite the apparent doom and gloom, the world’s economy continues to grow, year-on-year, creating wealth and return opportunities for investors.

As investors, we need to keep faith in capitalism as a robust and resilient economic system and recognise that the markets are an efficient mechanism for rewarding those who provide capital to those engaged in the pursuit of wealth creation.  The future looks bright from where we are sitting.

Accept that risk and return go hand in hand

One of the inescapable truths of investing is that to achieve higher returns, you have to take on more risk.  That seems logical enough, but you would be surprised just how many investors seem to think that it is possible to get high returns with low risk.  Yet risk should not be feared, because when appropriate risks are taken, they are the source of returns that investors seek.

mortality rates have fallen by over 50%.  Despite the apparent doom and gloom, the world’s economy continues to grow, year-on-year, creating wealth and return opportunities for investors.

As investors, we need to keep faith in capitalism as a robust and resilient economic system and recognise that the markets are an efficient mechanism for rewarding those who provide capital to those engaged in the pursuit of wealth creation.  The future looks bright from where we are sitting.

Accept that risk and return go hand in hand

One of the inescapable truths of investing is that to achieve higher returns, you have to take on more risk.  That seems logical enough, but you would be surprised just how many investors seem to think that it is possible to get high returns with low risk.  Yet risk should not be feared, because when appropriate risks are taken, they are the source of returns that investors seek. s – is that it is not a game worth playing.  Letting the markets do the heavy lifting on returns takes a great weight off your shoulders; you no longer need to worry about picking the right stock, the right manager or deciding if you should be in or out of the markets.  As one cannot control the returns of the markets, the structure of your portfolio becomes key.

Be patient – think long-term

One of the great challenges that all investors face is that there is no easy or quick way to investment success.  Aesop’s fable of the tortoise and the hare is a useful metaphor.  You have to use the time on your side – which could be over multiple decades – to capture the returns of the markets effectively, but often slowly.  In the short-term, market returns can be disappointing. The longer you can hold for, the more likely the returns you will receive will be at worst survivable, and hopefully far more palatable.  It is time that allows small returns to compound into large differences in outcome for the patient investor.  The reality is that markets go up and down with regular monotony.

If you want to be a good investor, you have to be patient.  On your investing journey, you will spend a lot of time going backwards, recovering from the set back and then surging forward again, often in short, sharp bursts of upward market movement.  You just have to stick with it.  Remember that you have to be in the markets to capture their returns.  Impatient investors tend to lose faith in their investments too quickly, with often painful consequences.

Be disciplined

Patience and discipline are close bed fellows.  Once you realise that to generate good long-term returns takes time, patience and belief in the markets, it is essential to put in place the discipline to stop yourself succumbing to impatience and ill-discipline.  Discipline comes in many forms: sticking to the principles above; constructing well-researched and tested portfolios that should weather all investment seasons relatively well; not chasing investments that have gone up dramatically, but sticking with the logical reasons for not owning them in the first place; and the discipline to not become despondent about short-term, unimportant market noise, and to focus on your long-term strategy.

become despondent about short-term, unimportant market noise, and to focus on your long-term strategy too often.  If you look at your portfolio every day you have about a 50/50 chance of seeing a loss, yet over five years that drops to around a 1-in-10 chance, falling further to around a 1-in-20 chance over 10 years.  Time is your friend.

The first thing to remember is that there is no absolute best way to construct a portfolio, but there are certainly some portfolio structures that are more sensible and more robust than others.  A brief outline of our portfolio construction approach is provided below.

1. Deciding on the asset class menu

One of the biggest challenges that all investors face is deciding what asset classes to invest in and what to avoid.  The spectrum of choice is wide, from cash and UK equities, through to fine wines and Ecuadorian rainforest.  We base our choices on each asset class’ ability to meet our pre-determined selection criteria.  The discipline of this framework allows us to review any asset class or investment strategy that crosses our desks in a systematic way.  Having to analyse it against our criteria, forces us to engage our reflective mind, which defuses much of the emotion that might exist.  Being entirely comfortable with the assets held in your portfolios ensures that when markets get tough, as they will from time to time, you are better placed to remain disciplined and stick with the strategic decisions that were made in calmer waters.

Growth and defensive assets – the two components of your portfolio

Your portfolio will comprise two components; the first is what we call ‘growth’ assets, which are higher returning, equity-like assets.  To own an entire portfolio made up of these higher risk investments – however well-diversified – would take some staying power when markets are in turmoil.  So, most investors require a balancing allocation to assets that perform a high-quality defensive role, which tends to be predominantly high-quality bonds. We call these ‘defensive’ assets.

• Growth assets – the engine of portfolio returns

The growth assets component of your portfolio represents a logically constructed, globally diversified mix of risk assets that seeks to deliver strong mid-single digit, after-inflation returns over medium to longer-term investment horizons.  Developed market equities (e.g. the US, UK, Germany and Japan) sit at the core of the growth assets component.  We also include – in moderation – return enhancing assets such as emerging market equities (e.g. China, Taiwan, Brazil and South Korea), smaller companies and less financially healthy ‘value’ companies, which, on account of their higher risk, should deliver a return premium.   Global commercial property – being offices, retail and industrial buildings – can be a useful diversifier. The growth assets component of your portfolio is highly

diversified at the asset class, geographic, sector and company levels, and contains exposure to several thousand companies in over 40 markets.

This part of your portfolio will be volatile, with negative returns likely in around one-in-three annual periods; that is fine, as it is the nature of markets.  Large falls in value may well be experienced at times of market turmoil.  Remember that a fall only becomes a loss if you sell, something that patient and disciplined investors should avoid. Remember, too, that your holding in defensive assets will help to reduce any fall in the value of your portfolio at these times.

• Defensive assets – balancing the portfolio

For more cautious investors – with low levels of growth assets – defensive assets provide lower levels of potential falls than equity markets and should preserve purchasing power over time, although this is not guaranteed.  For investors with higher levels of growth assets, defensive assets provide strong protection against equity market trauma.

Returns are expected to be only a little above inflation over the longer term.  Short-dated, high credit quality bonds provide useful defensive properties.  Their short-dated nature – the amount of time until the bond matures and capital is repaid – tends to lead to lower volatility than longer-dated bonds.  High credit quality – on average around AA credit rating – tends to attract money fleeing from riskier assets at times of equity market trauma, driving prices of these bonds up.  Any currency risk is hedged out, to avoid the volatility associated with exchange rate movements.  Inflation linked bonds, such as the UK index-linked gilts, can provide an insurance policy against this risk, and may be included in your portfolio.

We hope that this short note has provided you with a good insight into the key principles and investment practices that guide our systematic approach to investing.   We are confident that our approach will provide you with every chance of having a successful investment experience.  We cannot guarantee what returns the markets will deliver in the future, but we can guarantee that you will capture most of what is available through our systematically managed, best-in-class funds.  By owning a well-diversified portfolio for all seasons, having faith in capitalism, allowing the markets to do the heavy lifting, being patient and remaining disciplined, you give yourself – with our continued help and guidance – every chance of success.

If you have any questions on anything in this document, or you would like to talk through our investment approach in more detail, please contact us and we can arrange a time to talk.