NOBEL PRIZE INVESTMENT STRATEGY

Most investors seem to worry about picking the right stocks and buying and selling them at the right time. Abundant research on more than £500 billion of investments shows that it is very difficult and lack of expertise generally means most private investors take above average risks for below average returns.

A MUCH BETTER STRATEGY

Concentrate on building an investment portfolio that has a balance among asset classes - stocks, bonds, cash, etc. This can be done by applying some of the practical ideas of economists Harry Markowitz and William Sharpe, who won the 1990 Nobel Memorial Prize for Economic Science. Their ideas are known as ‘Modern Portfolio Theory.’

The Modern Portfolio Theory helps an investor toward his or her financial objectives, while minimizing both risk and investment expenses. It guides many investment managers and other institutional portfolios around the world.

A word of caution however some less experienced investment advisers believe that you can literally apply all the findings of Modern Portfolio theory (MPT) to making investments. You cannot! In the real word the detail breaks down –what we do is take some of the best ideas of MPT as a basis on which to build good long-term portfolios. 

MODERN PORTFOLIO BASICS

• Investment Selection.

The selection of individual investments has only a small impact on performance. Far more important is the allocation of funds among asset classes. The decision about how much to put in shares as an asset class versus bonds as a class will have more impact than the decision about whether to buy ICI or Marks & Spencer shares, for example.

The right combination of assets for a given level of risk is known as an efficient portfolio (see Efficient Portfolio page).

• Use of Timing Strategies.

Markowitz and Sharpe’s study indicated that market timing strategies seldom work. About 70% of market timers (people who use input such as recent past market fluctuations or the leading economic indicators to predict and profit from short term market performance) under perform the average. Long-term allocation strategies work better.

• The Efficient Market Concept.

In a totally free market, where all investors have all publicly available information, the value of the security would equal the asking price. This is considered an "efficient market". While some markets, such as US shares, are far more efficient than others, it remains true that hardly any markets are truly efficient and good managers can sometimes obtain out performance. This is an area where we disagree with some follows of MPT but we are looking at real empirical evidence.

Conclusion: In some markets buying an asset class through "indexing," a technique that uses the performance of an arbitrarily chosen group of securities to represent the risk and return characteristics of a given asset class e.g. a tracker fund can be beneficial but not always.

• Minimize Investment Risks.

To minimize risks, a portfolio must be put together with asset classes that have a low correlation coefficient. Meaning when one asset class is down, it’s likely another asset class in the portfolio will be up.

Example: When the stock market crashed in October of 1987, the bond market had one of its best days of the entire decade. So a portfolio with the right balance of stocks and bonds would have held steady, overall.

• Minimize Transaction Costs.

Transaction costs, brokers commissions etc, can have a significant adverse impact on portfolio performance. They should be kept low by minimizing trading and using fund supermarket and wrap accounts that facilitate low cost switching.

COMPUTER HELP

One can manage one’s own portfolio by purchasing personal computer software known as optimisers, which help you determine the best way to allocate your funds. But this software is costly, because it requires continuing, massive data updates.

Also many are based on biased opinions and false premises (one proponent we looked would have even a low risk investor with much of their portfolio in emerging markets funds).

We use high quality analysis software and use administrative platforms run by secure companies.