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Developing an investment philosophy for your clients

By Andrew Doherty
August 17 2016
5 minute read
Developing an investment philosophy for your clients
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Adopting an investment philosophy with your SMSF clients will ensure investment decisions are consistent and will help guide the appropriate response when unforeseen events occur.

Investors without a roadmap for success will find it very difficult to achieve their goals. An investment philosophy is a set of guidelines that inform investors’ decisions over time. By thinking through where they are going and how they plan to get there, investors are far more likely to have success.

This provides a critical central set of shared beliefs and parameters that can be referred to frequently, guiding all decisions. An investment philosophy will not be able to predict unforeseen events like market crashes or personal cash flow shortages, but it will help guide a response when they do occur. Without an agreed approach, decisions are more ad hoc, inconsistent and more likely to end in poor performance. So what aspects should be considered when establishing an investment philosophy with your clients?

Meeting the client’s needs

A holistic approach to investment management is more likely to meet the unique needs of each individual investor.

Strategic asset allocations, or the investors’ very long-term portfolio plan, should be intrinsically tied to how investors’ think about risk and return. The specific portfolio design should be determined by investor-specific objectives and risk tolerance.

This analysis includes understanding the proportion of income versus growth-style assets that are suitable for the investor as these lead to very different portfolio outcomes. The right asset mix differs for each individual and is likely to change as investor circumstances change.

High quality

Investment goals are more likely to be achieved through an actively managed long-term focus on attractively-valued, higher-quality assets.

For equity investors with a patient attitude, it is better to target outstanding businesses that are more likely to outperform over the long term. Attractive businesses are able to continue to invest capital at high rates of return, thereby creating value over time. They possess sustainable competitive advantages through unique assets or skills and strong industry positions in relation to barriers to entry, rivalry, strength of consumers, power of suppliers and degree of substitution.

Companies with more predictable cash flows are also less likely to disappoint, will be more readily valued and will have less volatile share prices. Cash flow predictability is determined by revenue cyclicality, operating leverage, balance sheet strength and risk of unforeseen events.

It is wise to limit portfolio exposures to less reliable situations, for example enterprises based in emerging markets where liquidity, foreign exchange and political risks are higher and corporate governance structures are weaker.

Similarly, SMSF practitioners may want to limit their client’s exposure to commodity prices due to their characteristic volatility and poor predictability.


Once SMSF practitioners have helped their client narrow down the investment universe to select high-quality assets, potential returns can be boosted by seeking assets trading at attractive prices relative to their underlying fundamental value. Overpaying for assets can cause weak returns or capital loss.

To improve investment outcomes, dynamic investors adjust asset allocations based on their assessment of expected returns for each asset class in relation to the required returns. Required returns differ for each asset class according to their inherent uncertainty. SMSF practitioners should ensure there are greater returns for higher-risk assets.

Within our direct equities investment process, we pinpoint companies trading at attractive prices via a variety of proprietary metrics including our detailed long-term forecasts of revenues, expenses and cash flows.


Broad diversification, actively managed across asset classes and sectors, enhances potential returns and reduces the potential for permanent capital loss or unacceptable portfolio volatility.

Domestic and international stocks, bonds, property, fixed income and cash tend to behave differently over time. Returns are likely to be enhanced and risk of permanent capital loss reduced by investment in a diverse array of attractively valued higher-quality assets.

The appropriate weighting between asset classes depends on the investor’s goals and risk tolerance, overlaid with the relative-return opportunities of each asset class.

Disciplined investors oppose transactions that diworseify the portfolio by increasing the number of instruments held while not contributing to risk-adjusted returns. We are less concerned with tracking error, that is, the degree to which returns match market index returns, than helping clients achieve financial objectives and preserving capital. Quality and value are greater priorities than diversification, as long as the portfolio design sits within the investor’s broad strategic asset allocation range.

Macroeconomic overlay

Macroeconomic analysis should help inform tactical asset allocation and equity portfolio tilts to ensure greater weighting to high-conviction opportunities. Fixed income asset allocations and duration and credit-quality exposures should be informed by the longer-term economic outlook and resultant interest rate expectations.

Key long-term global and local forces like aging western world populations and emerging Asian middle classes should inform security selection and portfolio weights.

Margin of safety

Application of a margin of safety in relation to buy and sell trigger points increases potential gains while reducing the chance of capital loss.

To allow for characteristic uncertainties in forecasting asset returns, SMSF practitioners should ensure clients buy at a discount to fair value. This provides a cushion against errors in the investment arithmetic. The appropriate discount, or margin of safety, is larger for more volatile asset classes and securities.

Patience and discipline

A patient and disciplined approach with a steadfast commitment to an investment philosophy and process promotes the likelihood of successful outcomes while reducing the risk of permanent capital loss. A structured and methodical approach reduces the risk of error through emotion-led decisions.

Long term

A long-term approach to investing gives asset prices the time to gravitate toward underlying fundamental value. With so much of the market focused on short-term gains, and with human instincts of fear and greed frequently causing asset prices to overshoot their underlying value, a different perspective offers opportunities to take advantage of mis-pricing in asset markets. The short-term focus of the majority of market participants means asset prices often reflect short-term factors more than longer-term fundamental factors.

A long-term approach allows investors to maximise the powerful benefits of compound returns. Time, return and re-investing are the sources of substantial fortune. As Albert Einstein famously professed,

By way of example: $10,000 invested at 9 per cent per annum but paid out each year for ten years generates a gain of $9,000. Reinvesting each year’s return generates a total gain over ten years of $13,670, or 52% more than if the return is paid out each year.

A long-term approach also typically results in fewer transactions which boosts returns over time through lower transaction costs like brokerage and administration-related expenses.

Simple and cheap implementation

Investors should seek low product and implementation costs to boost returns. Product costs within our portfolios can be significantly below most investor portfolios through a focus on direct securities and exchange-traded- funds (ETFs).

A low turnover nature reduces the administration burden for investors and advisors, and cuts brokerage and other transaction costs.

Tax considerations should be given healthy regard including through longer holding periods and preference for tax-beneficial treatments like franked dividends, other things equal.

Andrew Doherty, director, AssureInvest