How did you feel during the equity market sell off in February? Do you have an appropriate investment strategy in place that is specific to your family’s needs and wants? Do you have a robust investment governance framework in place that helps guide you through periods of market volatility?
The recent sudden spike in volatility and dramatic sell off in global equity and bond markets is a good reminder of how fickle investment markets can be. Making emotional or ill-considered decisions during these times can be detrimental to your chances of achieving your long-term investment objectives.
Empirical evidence suggests that strong governance frameworks can provide families and fiduciaries with considerable benefit by reducing risk and improving returns. Research also suggests that good governance can provide a positive impact to returns of 1% to 2% annually over the long term.
A strong governance structure encompasses the responsibilities of various types of decision makers within an investment program and how these decision makers relate to one another. The most important function a family or fiduciary performs is the setting of clear and measurable strategic objectives that is commensurate with their willingness to bear risk.
Mutual Trust’s investment advisors consult closely with clients to fully understand their financial goals and objectives, i.e. how much income do they need each year, what are their growth expectations with reference to inflation, what’s the time horizon and what are the key tax considerations? An appropriate benchmark is defined during this process.
Risk tolerance refers to an investor’s willingness to bear adverse outcomes in pursuit of their investment objective. Risk can take many forms, such as the volatility of expected returns, permanent loss of capital, unreliable income streams, inflation risk reducing the capital’s purchasing power and liquidity risk.
Higher returns typically come with higher risk and reduced liquidity. Your tolerance to the risk of loss of capital is a significant factor when arriving at an asset allocation. Typically, an investor needs to find a balance between how much risk they are willing to take to achieve their investment objectives.
We work with clients to incorporate the key elements of the investment objective, time frames and risk tolerance into an Investment Policy Statement (IPS), alongside other critical governance and regulatory requirements. The investment policy is a long-range strategic plan – it identifies the family’s specific investment goals and how they expect those goals to be realised. A comprehensive investment policy addresses:
- The family or fiduciary’s mission (purpose of wealth) and investment objectives
- Risk tolerance (willingness of family members or fiduciaries to bear investment risk)
- The policy asset mix (Strategic Asset Allocation)
- Performance evaluation
Mutual Trust advisors will recommend a tailored asset allocation mix to help achieve clients’ risk-return trade off. Typically this contains an appropriate mix of defensive assets such as cash and fixed interest, plus growth assets, including domestic and international equities, property and alternatives. We then implement and manage the portfolio inline with the agreed guidelines, documented in the IPS.
Performance evaluation is measured and presented with reference to the IPS. Regular reports provide clients with an update on total portfolio performance and asset allocation versus the agreed benchmarks. The investment policy serves its most useful role as a stabiliser in stressful markets. Sticking to the investment policy fundamentals reduces the risk of making counterproductive changes at the wrong time.
Reference: Improving Pension Fund Performance, Ambachtsheer et al., 1998.
Mutual Trust Pty Ltd ACN 004 285 330 (AFSL 234590). Liability limited by a scheme approved under Professional Standards Legislation. For participating members (other than for the acts or omissions of Australian Financial Services Licensees). This information is general in nature and subject to change. It does not constitute tax, legal or financialadvice. We recommend you seek advice specific to your circumstances before taking any action. Copyright © 2014 Mutual Trust Pty Ltd.