Kleinwort Hambros writes:
Our investment philosophy centres on three guiding principles:
1. Get the big decisions right: asset allocation will be managed dynamically.
But what does that actually mean? Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.
Dynamic management means that there is no fixed asset allocation. Rather, we move our allocations around (for example increasing or decreasing weight to equities) in order to maximise the risk/return reward from portfolios as we see fit.
2. Take risk only when risk is likely to be well rewarded: valuation will be the key driver of long-term returns.
In short - when assets are expensive, risk is not well rewarded; when assets are cheap, it is!
3. Avoid large losses: your portfolio will be constructed in a way which will seek to withstand market stress scenarios.
Prudence is essential, we believe that the pain of losing money – the ultimate definition of risk – is much worse than the fleeting joy of spurious gains.
What about VaMoS?
Our VaMoS framework puts our investment philosophy into practice. Organised around three core pillars, it provides structure to our investment decision making, through objective analysis of what can be shown to drive future investment returns.
Valuations: Favour assets with good fundamentals trading on attractive valuations while avoiding weak and expensive assets.
The golden rule is to invest in assets when they are cheap, avoiding them when they are expensive. This may feel Intuitive - why would you want to overpay for anything? Yet how do you go about identifying whether something is overvalued or not?
There are a number of ways to look at valuations. Let’s take equities as an example. Here, the price earnings multiplier (price paid per share / earnings per share) is essential. In bond markets, look at the yields or income that you are receiving.
Momentum: Acknowledge and exploit market behaviour – e.g. by buying assets that are trending higher and selling any assets that are trending lower
It’s important to remember that prices in financial markets are set by human beings (buyers / sellers.) Humans are vulnerable to the fear of missing out – the FOMO effect – meaning that when something starts to gain momentum, this feeds itself.
A priority for us is investing in positively trending assets that are gaining momentum and avoiding those that are negatively trending.
Sentiment: Add to risk assets when investors are overly pessimistic and reduce exposure when investors have become overly optimistic
This is the contrarian aspect of our framework, doing what humans find so difficult – going against the herd!
When an asset class or investment is overly loved or overly hyped, then there is a euphoria around it that is typically a cause for concern for us. On the flip-side, when there’s a lot of negativity and pessimism, then we pay close attention because that’s typically when investment opportunities in the form of value present themselves.
Of course, none of this happens in a vacuum: the economic scenario is of critical importance.
Macroeconomic factors directly impact the ability to generate earnings, pay dividends and service debt… all crucial inputs into understanding future cash flows. Such future cash flows – and by extension, asset prices – are particularly sensitive to two fundamental realities:
1) How much is being produced now? (i.e. gross domestic product)
2) Is this figure going up or down? (i.e. economic momentum).
By analysing certain data sources, you can answer these two fundamental questions and identify the prevailing economic environment as one of the following four regimes: Recovery, Expansion, Slowdown and Contraction. Each of these scenarios has different risk premia for Equities and Bonds.
We carefully adjust the level of portfolio risk, taking into consideration expectations for individual asset classes according to these different stages of the macro-economic cycle.
Please be aware that past performance of investments should not be seen as an indication of future performance and the price and value of investments can fall as well as rise.
***
For more information, please contact Sam Hartles sam.hartles@kleinworthambros.com