The science and art of portfolio construction

Jeremy Blatch

Malaga

Friday, 8 March 2024, 15:57

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Successful construction of an investment portfolio for the long term requires full measures of science and of art. The late David Swensen, chief investment officer of the extraordinarily successful Yale Endowment, gives insight on how to achieve this in his book Unconventional Success: A Fundamental Approach to Personal Investment. If investing in risk assets like equities, the time horizon over which the investor wishes to invest is crucial. If wishing to protect existing capital or grow capital by investing in risk assets, the investor must be comfortable holding investments for a minimum of seven to ten years. This assumes that the investor has made provision for income from other sources. There is nothing more damaging to an investment strategy than selling securities to raise capital at the wrong time. If done regularly, this will render the strategy impotent and produce poor investment results.

Common-sense incorporation of individual characteristics into the allocation of assets is key to constructing an investment portfolio. Devoting significant time and knowledge to the science and art in designing long-term portfolios increases the likelihood that investors will maintain a steady course amid the turbulent crosscurrents endemic to security markets.

The author is a member of the Society of Trustees and Estate Practitioners and an investment counsellor The comments and observations by the author are a reflection of his opinion and do not constitute an offer to buy and hold securities, nor does he receive any remuneration of any kind from names referred to.

Diversification provides the only free lunch to the hungry investor, helping produce risk-adjusted returns, and a bias towards the risk asset of equities promises the possibility of greater wealth accumulation. However, you can over diversify.

Individual personal preferences play a critical subjective role in a portfolio decision, and if an investor does not wholeheartedly embrace a particular portfolio structure, failure is guaranteed. Positions held with little conviction invite casual reversal, exposing vacillating investors to the costly consequences of being whipsawed by the market. By adopting asset allocation targets, investors vastly increase the odds of success.

Individual circumstances introduce important considerations to the structuring of a portfolio. Non-financial assets so often ignored by investment managers, such as homes, mortgages and personal loans, should be considered when making asset allocation decisions.

The heart of the investment process lies in producing a coherent set of portfolio targets that reflect the science of applying fundamental investment principles whilst incorporating the art of meeting investor needs and preferences. Thoughtfully constructed and individually chosen allocation targets provide the strongest foundation upon which to build a successful investment programme. How is your portfolio structured?

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