Investment Methodology

Investment Approach

Our investment approach encompasses:

  • Determining the risk tolerance of clients
  • Determining the asset classes
  • Identifying suitable ETFs for each of the asset classes
  • Determining the optimal mix of asset classes
  • Constructing customised portfolios based on risk tolerance of clients
  • Rebalancing and continuous management of the portfolios

Determining the risk tolerance of clients

We believe that sophisticated algorithms can do a better job of evaluating risk than the average human advisor. We split the questionnaire to determine the prospective client objective and subjective risk tolerance. Few questions will be based on objective risk to determine the ability of the prospective client to take risk, and the rest of the questions will be on subjective risk to determine their willingness to take risk. We will identify and factor in for any inconsistencies in the manner in which the client answers those questions based on subjective risk.

Determining the asset classes

The first step in our methodology is to identify a broad set of diversified asset classes. The availability of various ETFs traded in the exchange is also factored into while identifying the asset classes. These asset classes provide the main structure to our portfolios. We also evaluate each asset class on its potential for capital growth, income generation, volatility, correlation with the other asset classes which can be referred to as diversification, inflation protection, and the cost to implement the portfolio using ETFs. We attempt to determine the asset classes in our portfolio in such a manner that these asset classes are relatively uncorrelated.

We invest in eight Exchange Traded Funds (ETFs) across six asset classes; the funds we choose do not try to beat the system but rather track a wide spread of assets, thereby reducing risk via diversification. We invest with an equity orientation to maximize long term returns.

The asset classes are:

  • Australian shares
  • International developed market shares
  • International emerging market shares
  • Dividend shares
  • Bonds
  • Natural resources such as gold

Identifying suitable ETFs for each of the asset classes

We prefer to use ETFs to track the indices of of various asset classes used in our portfolios. We prefer ETFs with low annual expense ratios, minimal tracking error, low bid/ask spread costs, sufficient liquidity and minimal lending of the underlying securities of the ETFs. We are transparent about the reason for us selecting one ETF over the rest of the ETFs catering to the same asset class. Our reasoning for this decision making is available in the website for our clients.

Determining the optimal mix of asset classes

We adhere to the Fama/French school of thought. We aim to gravitate towards the Efficient Frontier by using Mean-Variance Optimisation (MVO) which is the foundation of Modern Portfolio Theory (MPT). After determining the asset classes and the suitable ETFs for each of the asset classes, we calculate the optimal mix of those asset classes by using MVO and other analysis.

The goal is to create each portfolio by determining an optimal mix of asset classes that maximises the expected return for a specific level of given risk. This risk is as determined for each client. The other way of looking at this goal is to minimise the risk for a specific expected return of the mix of the asset classes. So the intention is to calculate the best risk-return trade off by finetuning the mix of asset classes.

Constructing customised portfolios based on risk tolerance of clients

The different characteristics of each asset class can have a significant impact on the performance of the portfolio of the client. Diversification is a major aspect in our philosophy. This is because the asset classes generally perform different to each other as market conditions change.

We adopt minimum and maximum allocation constraints for each of the asset classes. This is to achieve appropriate portfolio diversification, to mitigate any estimation errors, and to factor in the client preferences.

Rebalancing and continuous management of the portfolios

QuietGrowth performs periodic rebalancing of the portfolio of the client for risk-adjusted returns. This is because the initial mix of investment allocation of the client drifts over time from the target allocation of the client. In order to maintain the intended risk level and asset allocations, a portfolio must be periodically rebalanced back to its original target allocation. We use sophisticated algorithms to optimise the portfolio rebalancing effort. We rebalance the portfolio of each client to bring back the investment mix in line with the client's target asset mix.

Asset class correlation assumptions

1
2
3
4
5
6
7
8
1Vanguard Australian Shares ETF 1.0 0.8 0.6 0.7 0.5 0.9 0.2 -0.3
2Vanguard Australian Shares High Yield ETF 0.8 1.0 0.7 0.4 0.2 0.8 0.7 0.3
3Vanguard US Total Market Shares Index ETF 0.6 0.7 1.0 0.6 0.6 0.7 0.7 0.2
4iShares Europe ETF 0.7 0.4 0.6 1.0 0.9 0.6 -0.1 -0.6
5iShares MSCI Japan 0.5 0.2 0.6 0.9 1.0 0.4 -0.2 -0.6
6Vanguard Emerging Markets Shares ETF 0.9 0.8 0.7 0.6 0.4 1.0 0.4 0.0
7Vanguard Australian Fixed Interest Index ETF 0.2 0.7 0.7 -0.1 -0.2 0.4 1.0 0.8
8ETF Securities Physical Gold ETF -0.3 0.3 0.2 -0.6 -0.6 0.0 0.8 1.0

 

Correlation colour scheme

Positive
1.0
Negative
-0.6

The above correlation matrix is calculated on the basis of fund values with a daily interval, over a period of 10 years.

As on March 14, 2016