Successful investing hinges on many factors. Some cannot be controlled such as market returns. However, there are some factors that we can control. Millhaven believes that following these four principles will allow you to focus on the factors within your control, which can be an effective way to achieve long-term results.
It is our belief that proper investment management is about making unbiased, well-informed financial decisions and minimizing costly mistakes. There should be a reason and a process behind decisions, rather than hunches, emotions or media hype. We take an evidence-based analytical approach, infused with a solid dose of common sense.
At Millhaven, we believe that being active within the asset allocation of a portfolio is far more important than being active in security selection or stock picking. Academic research has verified that the allocation to the major asset classes accounts for the vast majority of variability in portfolio performance.
Our philosophy emphasises long term return forecasting compared to a risk free return, such as term deposits or government bonds. If returns are forecast to be lower than returns on risk free investments, we believe the correct asset allocation decision is to start reducing exposure to that investment, and to sell down completely when prices are very expensive.
LONG TERM FORECASTING
Investment returns come from both fundamental elements and also sentiment; however over longer time periods it is fundamentals that are much more influential. When we forecast investment returns we are looking forward 10 years, and we accept that in shorter time frames our views can diverge from consensus.
We accept that there have been periods of up to several years where there is a gap between the forecast and actual returns. However the data clearly shows that over the long term the approach we use to predict future returns is a reliable indicator.
In simple terms, when the forecast process predicts relatively high future returns, then above average returns have consistently been produced.
DYNAMIC ASSET ALLOCATION
Much of the investment industry adopts a stable asset allocation, perhaps with some small tactical tilts applied from time to time. By contrast we are comfortable making very significant moves in risky asset classes, including going to 0% exposure in order to avoid what we see as avoidable mistakes.
We implement an overweight stance in asset classes where we expect good future returns, though we do limit overall exposure to risky assets depending on the profile of the investment program. Expensive assets produce low future returns and often also mean large capital losses, and hence we reduce or eliminate exposure to these asset classes
Non dynamic, stable allocations ensures exposure to expensive assets, even those in a bubble, and eventually leads to wealth destruction.
CREATE CLEAR, APPROPRIATE INVESTMENT GOALS.
We believe that investors should set measurable and attainable investment goals and develop plans for reaching those goals. Investors with multiple goals (e.g. retirement planning and saving for a child’s education) should have a separate plan for each. Finally, they should evaluate their plans on a regular, ongoing basis.
ASSET ALLOCATION & DIVERSIFICATION
Build an appropriate and personal asset allocation using broadly diversified assets.
We believe that a successful investment strategy starts with an asset allocation that is specific to the objectives it is looking to achieve. Clients should establish an asset allocation using reasonable expectations for risk and returns. The use of diversified investments helps to limit exposure to unnecessary risks.
Figure 1. The mixture of assets defines the spectrum of returns
Best, worst, and average returns for various equities/bond allocations, 1962-2015
Diversification is a powerful strategy for managing traditional risks. Within an asset class (such as equities or bonds), diversification reduces a portfolio’s exposure to risks associated with a particular company or sector. Across asset classes, it reduces a portfolio’s exposure to the risks of any one class. It cannot eliminate the risk of loss, but it can help to protect against unnecessarily large losses resulting from the under performance of one portion of the portfolio. Undiversified portfolios also have greater potential to suffer catastrophic losses.
Investors can’t control the markets, but they can control how much they are willing to pay. Every dollar that investors pay for management fees or trading commissions is a dollar less of potential return. In addition, our experience has been that, historically, lower-cost investments have tended to outperform higher-cost alternatives in the long term.
MAINTAIN PERSPECTIVE AND LONG-TERM DISCIPLINE
Investing can evoke emotion that could disrupt the plans of even the most sophisticated investors. Some make rash decisions based on market volatility, but investors can counter that emotion with discipline and a long-term perspective. They should adopt a systematic approach to investing based on the principles of asset allocation and diversification—and then stick to that plan.
Rebalancing brings the portfolio back in line with the asset allocation established to meet the investor’s objectives. We believe that investors should check their asset allocation once or twice a year.
When equities are performing poorly, investors may naturally be reluctant to sell, for example, bond funds that are performing well and buy more equity funds. But the worst market declines can lead to the best buying opportunities. Investors who don’t rebalance their portfolios during these difficult times may be jeopardising their long-term investment goals.
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