Investment Methodology

We strive to serve you as the most advanced digital investment adviser in Australia. Behind the algorithms that we have been designing and improving, we have a robust investment methodology. We adhere to the Chicago School of Thought, whose influence in our working is mainly because our founder, Dilip Sankarreddy, was trained at The University of Chicago. We stress the academic prowess of an investment idea or concept, enabling us to serve our clients as an advanced robo advisor.

Our investment approach encompasses:

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

Determining the risk tolerance of clients

We believe that sophisticated algorithms that are thoughtfully designed, can do a better job of evaluating the risk tolerance of a client, compared to how an average human financial adviser evaluates the risk tolerance of that client. If the scope of the problem statement is limited to long-term risk-optimised investing, then the effectiveness of these high-quality algorithms can be on par with the effectiveness of a high-quality human investment adviser.

We determine both the objective risk tolerance and the subjective risk tolerance of the projective client. For that, we split the questionnaire to assess the objective and subjective risk tolerance of the prospective client. Some questions in the questionnaire 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 her willingness to take risk. We will also identify and factor in for any inconsistencies in the manner in which the client answers those questions meant to assess the subjective risk tolerance.

Our methodology to determine the risk tolerance of the client has various aspects such as:

  • Objective ability of the client to take risk based on her projected savings after expenses throughout her working years, projected retirement income, and projected retirement spending needs
  • Subjective willingness of the client to take risk
  • Consistency of responses given by the client to the questions used to determine her subjective risk tolerance

We ask objective questions to determine whether the client is in line towards her saving enough money to afford her likely spending needs for the rest of her life. This also helps us in partly determining how much risk the client can take with her investments.

We also ask subjective risk questions to determine the level of risk a client is willing to take. Understanding the attitude of the client towards risk is important because ultimately the client needs to be comfortable with the risk element of her investment plan.

Analysing the consistency of the answers given by the client for the subjective risk questions helps us to know whether the client understands the questions that we ask. For example, if the client is willing to take a significantly higher risk as per her response to one subjective question, and is willing to take a much lower risk as per her response to another subjective question, then she is inconsistent in her answers. Due to this inconsistency, we might assign a lower subjective risk tolerance score than she would have got otherwise.

Comprehensiveness of risk tolerance questionnaire

We have designed our client risk tolerance determination methodology in such a manner that a minimum number of questions are sufficient to determine the risk tolerance of the client to a reasonable accuracy. We are mindful of the number of questions we ask, and intend to ask as few questions as possible. We believe that our well-thought list of questions is sufficient and highly effective in identifying the risk tolerance score of a client accurately. After we create the QuietGrowth account for the client and the client starts investing, we will continue to gather more information about her so that the accuracy of our understanding of her risk tolerance improves progressively.

Rainy-day fund

We recommend that the client should set aside the requisite money for a rainy-day fund in term deposits, low-risk fixed-income instruments or cash. If the rainy-day fund comprises of a small portion of higher-risk equity exposure, then such instruments should be highly-diversified. It should cover at least six months of expenses to deal with any unexpected emergencies (such as unemployment, illness) that might arise in the lives of the client and the dependent family members. The rainy-day fund would also include six-month’s worth of any monthly payment commitments that the client might be having towards mortgages, loans or insurance premiums.

The client should not try to maximise the return-on-investment for her rainy-day fund. Instead, the client should ensure that her rainy-day-fund is less risky and is liquid. The probability of the rainy day fund losing a sizable portion of its value should be low, and the probability of having a high volatility in its day-to-day value should be low.

In case a client cannot afford to set up a rainy-day fund, then we take that into consideration while determining her risk tolerance. Refer to our knowledge resource 'What is a rainy day fund?' for more information.

Loans with high-interest rates

We recommend that the client should repay all the outstanding loans that have high-interest rates before she considers to invest for the long-term. Credit card loans, personal loans, overdrafts, buy now pay later loans and payday loans are certain types of credit that typically have high-interest rates.

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 maximise 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

Same asset classes for everyone

The same set of asset classes apply to everyone. We do not believe that a client should not have exposure to a specific asset class.

Thematic portfolios

We do not build QuietGrowth Portfolios as thematic portfolios. QuietGrowth Portfolios do not have extensive exposure to a short-term macroeconomic theme or trend, because it is tough to predict the outperformance of such a theme or trend.

Sector portfolios

QuietGrowth Portfolios are not sector-based portfolios. QuietGrowth Portfolios do not have extensive exposure to a specific sector, with an expectation of that sector outperforming the broad market indices in the short term. This is because it is tough to predict the outperformance of a specific sector.

Some of the prominent sectors we consider in our analysis are:

  • Consumer discretionary
  • Consumer staples
  • Energy
  • Financials
  • Health care
  • Industrials
  • Information technology
  • Materials
  • Real estate
  • Telecommunications
  • Utilities

Hedge funds

QuietGrowth Portfolios do not include hedge funds, as of now. Not all hedge funds are equal, and it is not preferable to invest in a hedge fund, just because that fund happens to be a hedge fund. Like most of the other alternate investment opportunities, it is prudent to stay away from most of the hedge funds, except for certain hedge funds that are best-in-class. However, it is difficult to participate in such high-quality hedge funds, especially with favourable terms of participation so that the interests of QuietGrowth clients are catered to. So, whenever QuietGrowth gets an opportunity to participate with favourable terms in these high-quality hedge funds, we will certainly consider.

Private equity funds

QuietGrowth Portfolios do not include private equity funds, as of now. Not all private equity funds are equal, and it is not preferable to invest in a private equity fund, just because that fund happens to be a private equity fund. Like most of the other alternate investment opportunities, it is prudent to stay away from most of the private equity funds, except for certain private equity funds that are best-in-class. However, it is difficult to participate in such high-quality private equity funds, especially with favourable terms of participation so that the interests of QuietGrowth clients are catered to. So, whenever QuietGrowth gets an opportunity to participate with favourable terms in these high-quality private equity funds, we will certainly consider.

Private companies and startups

QuietGrowth Portfolios do not include shares in private companies. We believe that the determination of the share price of a private company is less efficient compared to that of a publicly listed company. The liquidity of such an investment is typically lower. So, QuietGrowth would consider investing in private companies only when we build the capabilities to assess the investment opportunity of owning shares in a private company.

QuietGrowth Portfolios do not include shares in startups that are not public companies. We believe that investing in such startups should be done using the 'play money' of the client. Refer to our 'Startup Investing' knowledge resource for more information.

Cryptocurrencies

We recognise cryptocurrencies as an asset class. However, we have decided to exclude, as of now, this asset class in the construction of our portfolios. Refer to our opinion 'Investing aspects pertaining to cryptocurrencies' for more information.

Determining the optimal mix of asset classes

Efficient Market Hypothesis influences our investment methodology approach. We follow evidence-based investing principles to achieve risk-optimised long-term growth. We acknowledge the significance of 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, we calculate the optimal mix of those asset classes by using MVO and other analyses.

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. For this reason, the intention is to calculate the best risk-return trade-off by finetuning the mix of asset classes.

The same mix of asset classes applies to everyone with the same risk tolerance score.

Identifying suitable ETFs for each of the asset classes

We prefer to use ETFs to track the indices 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. ETFs that are traded on Australian Securities Exchange (ASX) and ETFs that are domiciled in Australia are preferred. We are transparent about the reason for us selecting one ETF over the rest of the ETFs catering to the same asset class.

We might choose more than one ETF in an asset class if we are of the opinion that there is no one single ETF available that can comprehensively represent that particular asset class.

Refer to our 'ETF Investing' knowledge resource for more information.

Same ETFs for everyone

Because the same set of asset classes apply to everyone, the ETFs that represent those asset classes are the same for everyone.

Ethical investing

While identifying suitable ETFs for each asset class, we do not give preference to Ethical ETFs. The metrics that we use for the selection of ETFs apply to Ethical ETFs too. Hence, none of the Ethical ETFs has become a part of QuietGrowth Portfolios so far, mainly because Ethical ETFs have higher expense ratios, lower diversification and no exposure to certain high-performing public companies.

Also, as of now, QuietGrowth is not offering ethical portfolios comprising only of Ethical ETFs. If you intend to do any specific socially responsible or ethical investing, then you will not be able to do it through QuietGrowth. We are cheering ethical investing from the sidelines. Refer to our 'Ethical Investing' knowledge resource for more information.

Smart Beta investing

We recognise the effectiveness of Smart Beta strategies in numerous scenarios. We believe that we can include Smart Beta ETFs in our portfolios, if these strategies have been proven to be effective in the past, and if we determine that there is a high probability that these ETFs continue to give desired results. It is good news that there has been an increase in the number of various Smart Beta ETFs, as it helps us to choose from a broader choice-set of Smart Beta ETFs. We monitor this emerging class of ETFs closely, and there is a possibility that we might include Smart Beta ETFs in our portfolios soon.

Constructing customised portfolios based on the 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 of our philosophy. This is because the asset classes generally perform differently 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.

Risk portfolios

We offer five different risk portfolios. Each of our portfolios is optimised to a specific risk profile of the client. The risk of our portfolios ranges from lower risk to higher risk, and the five portfolios are named as 1/5, 2/5, 3/5, 4/5 and 5/5 in increasing order of risk.

You can consider our QuietGrowth Portfolio 3/5 as a ‘balanced portfolio’ among our list of portfolios, because the risk of this portfolio is in the middle of the risk spectrum of QuietGrowth portfolios.

Investment horizon

We build risk-optimised portfolios with a long-term perspective. To enjoy the benefits of diversification of QuietGrowth portfolios in an increasing manner, the client would need to stay invested for at least 10 years. The probability of loss of the investment in a diversified portfolio decreases as the client stays invested for more number of years.

So, ideally, the investment of the client in QuietGrowth portfolios should not include those investments with a short time-horizon of a few months or a year. If the client is thinking of a big-ticket purchase, such as a house, within a year, and she cannot afford to lose a part of her money till the purchasing event because of market volatility, then she should not invest that amount in a QuietGrowth Portfolio. Instead, the client should park that money in a term deposit till the purchasing event.

Forming the core of core-satellite investing

If you adopt the core-satellite investing approach, then QuietGrowth portfolios can serve as the ‘core’. The highly-diversified, low-cost nature of QuietGrowth portfolios enables you to create the core of your investments with our risk-optimised portfolios. Then, depending on your or your traditional wealth manager’s preference, various other investment options, outside QuietGrowth portfolios, can serve as ’satellite’ allocations.

Benchmarking

We do not benchmark against any external accumulation index. This is because our portfolios are constructed without any intention to track or to outperform any external benchmark indices.

We benchmark the actual performance of a client's portfolio with a particular risk score against the comparative benchmark which is our own model portfolio with the same risk score.

Continual reassessment of the composition of QuietGrowth portfolios

Our investment team monitors various factors influencing the composition of our portfolios, and whenever our investment team determines that the target mix of a particular QuietGrowth portfolio needs to be altered, the portfolios of clients are transitioned to the new target mix as feasible. The decisions concerning altering the composition of the portfolios take place at least once in six weeks.

Rebalancing and continuous management of client 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. 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.

Rebalancing approach

We rebalance your portfolio periodically whenever we see that any one of the funds in your portfolio has drifted by a certain percentage from its target allocation that is mentioned in your Investment Program. Hence the trigger to rebalance is determined by threshold-based percentage drift. We believe that this method is preferable, instead of having a predetermined period based approach (such as rebalancing once every quarter, or once every year).

We will also consider various other aspects before we rebalance, such as the cash available to rebalance, the prospect and the size of any oncoming dividends, the volatility of each fund in your portfolio, and the impact on capital gains taxation because of rebalancing. Even though QuietGrowth absorbs the trading costs incurred while rebalancing and does not charge the client for these costs incurred, we are mindful of these costs too. Hence we rebalance when the dollar amount of the buy or sell trades to be executed while rebalancing is of a meaningful amount only.

We will be monitoring your portfolio continually for rebalancing. Whenever you deposit funds or instruct us to withdraw funds, we will also evaluate whether we can perform threshold-based rebalancing at that time as we determine the exact buy or sell trades of various funds that we might execute. That is, we will try to perform interim rebalancing at each of these instances.

The relative performance of each of the funds in your portfolio matters a lot towards rebalancing, and hence, we cannot predict when we are likely to rebalance your portfolio. Your dashboard will show by how much percentage each of your funds has drifted from its target allocation.

Rebalancing using the cash distributions

We prefer cash dividends or cash distributions instead of opting for a distribution reinvestment plan. The dividend or distribution amounts that are paid by different ETF issuers are deposited in your brokerage account. We reinvest the dividend or distribution amounts towards the purchase of ETFs by executing one or more buy trades. We prefer this portfolio management approach, instead of opting for a distribution reinvestment plan, because this allows us to attempt to rebalance your portfolio while executing those buy trades.

OTHER INFORMATION

Machine learning

We use machine learning technology for analysing the client data. We do not use machine learning for the construction of QuietGrowth Portfolios.

Other QuietGrowth resources related to our investment methodology