Investment Model Portfolios for Adviser Firms

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Where has our alpha come from?

The majority of our Investment Model Portfolios have performed well in a year that began with shocking market falls as COVID-19 spread around the world.  In fact, some of our portfolios have really excelled in both relative and absolute terms.  We thought that this level of outperformance warranted some further analysis, and have dissected where this alpha was generated.

Over-Arching Investment Philosophy

One of the key elements within our investment philosophy is the requirement for a higher degree of risk-adjusted returns.  This stems from a principle that focuses on implementing changes in portfolio that have the potential to increase returns in the most careful way possible.  Within this philosophy we have also generally kept a lower equity weight in portfolios (compared to their sectors’ average) and this has led to some very positive long-term performance.

Coming from a more defensive position than our peers (in most portfolios) at the end of 2019, our optimism for growth at the start of this year led us to propose a moderate increase to risk in some portfolios.   However, our instilled risk-aware philosophy meant that we made this a limited and incremental step-up and this was vital to our outperformance in the extreme falls in the first quarter as our portfolios fell significantly less than their peers.

The chart below shows the 2020 performance of three of our Balanced risk Investment Model Portfolios (the Whole-of-Market, Ethical and Passive) relative to their benchmark – the ‘IA Mixed Investment 40-85% Shares sector’ average:

GDIM Balanced IMP performance Dec 2020

A significant proportion of our outperformance against the sector average came during the biggest falls, in February and March of this year.  Holding a significantly less risky asset allocation was clearly very helpful in these difficult times, which were unusually sharp and swift. Our proactive and thematically based approach also helped us to outperform as the recovery in stock markets took place too, using more growth-based companies and avoiding the worst victims of the slow-down.

One good example of the risk-aware approach we take to asset selection is our addition of high yield bonds in July.  This asset class had followed equity markets down to very low levels but, with careful selection, many of these bond issues held much better prospects than were being suggested by their valuations.  As the situation clarified and the market rationalised their views, the recovery took place and we benefitted from this increase in value at a significantly lower level of risk than we would have in equities.

What we own and what we don’t

Our portfolios have been propelled by key holdings in technology stocks, but also in many ESG (or ethically)-focused funds that have enjoyed a significant tailwind throughout this year.  Other key over-weight positions we held were Europe – increased after the aforementioned dips in markets – and in high quality, globally diverse stocks, which provided defensive growth.

Just as important as these were our key under-weight positions.  A significantly lower UK equity weight saved us from being held back by the region’s sluggish performance.  An aversion to more cyclical, value-based stocks in sectors such as commodities and financials also benefitted our relative returns by their absence.

Winning by not losing

Over the longer-term, the lower degree of downside that we have participated in has led to outperformance on a consistent basis.  We regularly check our capture of market upside and downside and the positive participation is close to the ‘average’ fund’s (dependant on the risk level), but with a significantly stymied downside, the excess returns are strong.

This principled ethos has been positive for performance over the long term and our actively managed positioning has been vital to our success us in the shorter-term.  The latter is something that we must continually assess and mould to fit the global backdrop, thematic trends and changes in attitudes that are constantly in flux.  We will not always get all of these themes right, but we should be well-served by the strong foundations on which the portfolios are built.

Tom Sparke GDIMTom Sparke IMC CertPFS (DM)
Investment Manager | Associate Director