Portfolio construction
The building blocks we use to create your portfolio are based on science, not guesswork and are structured around your tolerance to risk, investment goals and allocation of assets.
By using a disciplined approach to portfolio engineering, the asset allocation decisions we make will determine more than 90% of your portfolio’s performance. In contrast, picking individual stocks and trying to time the market have far less influence on performance.
Definitions:
- Asset class selection: how assets are allocated in a portfolio
- Market timing: shifting portfolio assets in and out of the market or between asset classes
- Security selection: funding “underpriced” companies or industries
Equities – Three Factor Model
Within equities we apply a three-factor model, derived from almost six decades of financial market research:
- Market: stocks are riskier than bonds and over the long term have higher expected returns
- Size: small company stocks have higher expected returns and risks than large company stocks over the long term
- Price: lower-priced “value” stocks have higher expected returns and risk than higher-priced “growth” stocks over the long term
Fixed interest
To enhance returns within fixed interest we focus on two factors, being term and credit risk:
- Term risk: The risk of investing in fixed interest securities such as bonds for extended periods. In general, the longer the time until a bond matures, the more its price may fall due to changes in interest rates, inflation, supply and demand, risk aversion or other factors. Investors generally demand a premium as compensation for term risk, although this can vary widely.
- Credit risk: The risk associated with a bond issuer not being able or willing to honour its obligations. The price of a security may also fall due to the perceived risk of default increasing. Again, investors generally will demand an additional return as credit risk rises, but this margin varies.
Using the above five factors we design broadly diversified, low cost, structured portfolios that seek to add value through engineering and implementation. The majority of these strategies are managed by Dimensional Fund Advisors (www.dimensional.com.au).