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    Seed Weekly - Portfolio Construction

    Portfolio construction is a vital part of portfolio management. At Seed Investments it is an area that is extremely important, both when assessing other portfolio managers and also when managing solutions for our clients.

    What is portfolio construction?” you may ask?

    Portfolio construction is the process of building an investment solution, such that its performance is as consistent as possible. This is done through selecting assets that are uncorrelated with each other as well as getting their position sizing correct. In a Fund that has a relatively conservative risk budget (i.e. don’t lose capital over any 12 month period) but that at the same time has a moderate return objective (i.e. CPI + 4% pa over rolling 3 year periods) risk needs to be taken in order to generate the required return, but that risk needs to be managed and controlled in order to ensure the capital preservation target isn’t breached.

    Perhaps that easiest way to describe how portfolio construction works in the real world is to work through an actual example. The Seed Stable Fund has the same risk and return objectives as described above and has been able to deliver on these objectives through a meticulous focus on portfolio construction.

    The charts below show the risk and return of the underlying strategies within the Seed Stable Fund for the 12 months ending 31 August 2015 and 31 August 2016 (i.e. 2 non overlapping periods). Some key take outs are:

    • Property: High Yield strategy 12 month return drops sharply from 17.6% to -2.5%
    • Equity: High Yield strategy 12 month return rises sharply from 1.5% to 13.7%
    • Global: Absolute strategy 12 month volatility rises sharply from 8.5% to 17.2%

    Despite the sharp moves in the underlying strategies, the Fund’s 12 month return shifted up from 8.9% to 10.6% with its volatility only marginally moving from 4% to 4.5%.

    Source: Seed Investments, 3 October 2016

    Source: Seed Investments, 3 October 2016

    The Fund has been able to consistently achieve its risk and return objectives over this period as the performance of the underlying strategies are uncorrelated with each other, and the sizing of the strategies has also been prudently thought about. Property: High Yield has been highly volatile over this period, but the weighting has been kept lower than the other strategies, resulting in its volatility having a low impact on the overall Fund’s returns. Equally, while the Income: Flexible strategy has a very low volatility over both periods, its return has also been on the low side, and its low weighting within the Fund has also therefore been justified.

    Going forward, with equity markets at extremely expensive levels, we have increased the diversification of the equity centric strategies (Equity: High Yield) and (MA: TAA – Multi Asset – Tactical Asset Allocation) by including a third equity strategy (MA: Opportunistic) and also reduced the aggregate weighting to these higher risk strategies (as well as Property: High Yield) in favour of Income: Flexible as the return OF capital becomes increasingly more important than the return ON capital.

    By constantly reviewing our portfolio construction in this manner we strive to ensure that the risk and return objectives of all our Funds meet their stated benchmarks.

    Take care,

    Mike Browne

    Tel +27 21 914 4966
    Fax +27 21 914 4912
    Email info@seedinvestments.co.za

    Please click here to view our disclaimer. For more information please visit our website.

    Permalink2016-10-05, 08:34:50, by Mike Email , Leave a comment
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