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 on 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 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 can do a better job of evaluating the risk tolerance of a client, compared to how an average human financial advisor evaluates the risk tolerance of that client. The effectiveness of these high-quality algorithms can be on par with the effectiveness of a high-quality human investment adviser. 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

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 very difficult 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 very difficult 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 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 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.

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. For more information, please refer to our opinion 'Investing aspects pertaining to cryptocurrencies'.

Determining the optimal mix of asset classes

Our investment methodology approach is influenced by Efficient Market Hypothesis. 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.

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.

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 have become a part of QuietGrowth Portfolios so far, mainly because Ethical ETFs have higher expense ratio, 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. Please 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 in near future.

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.

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 very short time horizon of few months or an 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.

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. 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.

Other QuietGrowth resources related to our investment methodology