Portfolio Construction

Portfolio construction is simply selecting a ‘basket’ of investments – selected from available investment types such as cash, fixed interest, property, equities (shares) and even alternative investments – that take into account the investor’s objectives over the short, medium and/or long term.

It is about constructing a diversified portfolio of assets using an appropriate asset allocation strategy to enhance performance and minimise risk of the overall portfolio (or basket of investments).

Key steps to portfolio construction 

Portfolio construction

Asset allocation

Asset allocation is a key fundamental of portfolio construction and investing. Studies have shown that a large part of the variation in returns between different portfolios can be attributed to inappropriate allocation of assets, rather than market timing or individual investment selection.

There are four types of asset allocation methods used in the industry.

  1. Static – set the benchmark and hold
  2. Strategic – set the benchmark, regularly review and re-balance when required
  3. Tactical – short term tactical changes to "beat the market"
  4. Dynamic – based on macro trends, economic cycles, etc

Fundamentals of asset allocation

  1. Diversification
  2. Defensive assets vs Growth assets
  3. Time frame for investing
  4. Rebalancing the portfolio

Successful asset allocation means achieving objectives with the least possible risk.

Diversification benefits

Diversification of your investment portfolio across all asset sectors allows you to 'hedge your bets'.

By spreading your exposure and investing in different assets you create a portfolio in which you are able to minimise to some degree the losses that may occur in one asset sector with gains in another. The overall effect is that you moderate the risk and smooth out your investment returns over time.

Benefits

  • Exposure to a broader range of assets across the different asset classes
  • Optimise performance of a portfolio by having negatively correlated* assets
  • Minimises volatility of portfolio by spreading risk across various assets and asset sectors
  • Potential to yield higher returns with lower risk

Risk vs return

Each asset class comes with it its own element of risk. Understanding the risk/return trade-off for the various asset classes is very important.

That is, the greater the returns, the greater the risk you take, and vice versa.

It's how much risk you are prepared to accept from each class that helps determine your asset allocation.

Risk vs return graph

Contact us

If you stick to the basics of investing you will have a much better chance of getting through any period of high volatility and uncertainty. We can help you develop a portfolio that suits your investment goals. Speak with one of our experienced advisers for an obligation-free discussion.

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