Our Investment Director, Richard Urwin, summarises the success of our Investment Committee's strategy over the last five years and the reasons for our strong performance on behalf of our clients. We need to remind you, of course, that past performance is not necessarily a guarantee of future returns. Nevertheless, if you are one of our clients we think you'll be pleased by Richard's analysis.
As 2018 has drawn to a close and 2019 has begun, it seems appropriate to reflect on what was the first year of negative returns for our multi asset portfolios since 2011. The blue line on the chart below represents the actual returns achieved by clients invested in accordance with the CH Medium Risk portfolio since 1st January 2014. The red line represents the UK stock market index (based on the top 100 companies in the UK) with dividends reinvested. It isn't necessarily an appropriate benchmark for a multi asset class portfolio but it is one that most clients can relate to.
There are three elements of cost in the blue line: the cost of advice, the cost of the investment platform, and underlying fund management charges. Depending on portfolio size these costs amount to 2.3%-2.6% p.a. in total. This pays for a comprehensive financial planning service including tax advice, the use of multiple tax wrappers such as GIA (General Investment Account), ISA (Individual Savings Account) and Pension, and professional investment management. The UK stock market index (the red line) includes no costs, no stamp duty, no brokerage fees etc. and is therefore a hypothetical construct.
There are two periods of significant stock market declines highlighted and expanded on the chart, which are 1st June to the end of September 2015 and the 1st January to 20th December 2018. One of our objectives is to dampen the volatility of returns through diversification. In that respect portfolio returns in both time periods achieved this, with falls in value of around a third of those in the UK Stock Market index.
What is also pleasing is the net of fees result over the almost five years shown, i.e. 6.3% average annual compound return for the clients with a CH Medium Risk Portfolio against 3.6% p.a. for the UK Stock Market index.
Not many clients understand volatility as a measure of risk (not many advisers do for that matter) but most people can see the difference in the blue and red lines quite clearly. The blue line has fewer downward sloping months and all slopes are less steep. The monthly returns appear to be smoothed and this is essentially what diversification is designed to achieve.
Diversification is a simple concept but it's harder to achieve than one might think and this is particularly the case in periods of economic and political stress, when established relationships between different asset classes can break down.
We have all read that we should spread our eggs between different baskets - but if all of your baskets are in the same lift and that lift is going down, it won't matter much how many baskets you put your eggs in. The key is to understand the factors that will affect the performance of each basket and ensure that you include a wide range of risk factors.
We believe that it is possible to add value by varying asset allocation dynamically and our portfolios are run on this basis. However, this doesn't negate the need to diversify.
Things are made more difficult because the relationship between different asset classes does not remain the same. It is tempting to look at the correlation of investments in the past and to build portfolios based on that data. This analysis is important but on its own it is flawed. It's what I call the Jim Bowen style of investment, after the famous host of TV's Bullseye programme whose catchphrase was "look what you could have won!". What worked in the last five years may well not work in the next five, and a more thoughtful approach is required. The work of our Investment Committee is to review, adapt and plan our strategy and I'm pleased to say they are doing an excellent job of it.
Written by Richard Urwin, Dip PFS
Managing Director, Chesterton House Financial Planning Ltd