A Substantiated Approach
The ultimate goal of BNL Investment Management is to provide our clients with the greatest probability of achieving their goals and financial objectives. In this section, we briefly summarise the Bradley Nuttall Investment Management Process and underlying portfolios.
Click on any of the links below to be taken directly to that section.
- Investment Management First Principles
- How We Manage Wealth
- BNL Investment Management Committee
- Selecting Appropriate Investments
- Which Risks Pay
- Constructing Diversified Portfolios
- Which Portfolio Is Right For You?
- Needs Assessment
- Regular Review and Rebalancing
- Next Steps
Investment Management First Principles
To manage our client portfolios properly, BNL Investment Management is concerned with two fundamental concepts:
- Risk: This is the level of volatility of returns in your portfolio, measured by standard deviation. For example, if you own a high-risk portfolio it will increase fast in good markets and decrease fast in bad markets. In other words, over the short-term the portfolio’s value is very volatile. If you own a low-risk portfolio, the opposite is true. Your portfolio’s value will increase at a steadier, slower pace, and is more insulated from downward movements.
- Return: This is essentially the growth-rate of your portfolio. Given enough time, a high-risk portfolio will earn higher returns than a low-risk portfolio.
Risk and Return must be considered together. Although most investors want high return and low risk, this is not achievable in the long-run. The fastest way to find an investment charlatan is to look for the person offering high returns with low risks.
So, based on the level of risk you are willing take, how do you achieve the highest returns?
Through diversification and exposure to the types of risk that compensate investors with higher returns.
The following chart demonstrates the risks and returns of Bradley Nuttall (BNL) investment management portfolios over 24 years from 1991 – 2014, compared to an index that represents the returns of the New Zealand stock market (NZSX 50) over the same period. All BNL investment management portfolio returns are shown net of management fees, but gross of adviser and custodial fees. The NZSX 50 Index has no fee.
As shown in the above scatter plot, higher risk portfolios (seen on the horizontal axis) lead to higher returns (demonstrated by the vertical axis). However, the key is that by diversifying portfolios, we are able (over a significant 20 year time period) to increase returns relative to the NZSX 50, while taking less risk.
Our portfolios do not promise returns without risk; rather they employ financial science to identify those risk factors that lead to better investment outcomes.
How We Manage Wealth
We believe that good investment management begins with the right principles. Here are some of our principles at Bradley Nuttall:
- We begin with the end in mind: What do you want to do with your money? When do you need to use it? How can we make your financial goals and dreams a reality? We develop wealth management strategies with our clients’ goals and dreams firmly in focus.
- We put our clients first. You can trust our investment advice because we have no products to sell, take no commissions, and have no conflicts of interest where we serve our clients. We have a specific objective, which is to help our clients achieve their goals.
- Investment returns are the result of holding investment risk: How much risk should you hold in your investments? How much risk are you bearing in your portfolio right now? Many investors can’t answer either of these critical questions. These questions are important because risk forms the basis of investment returns. Bradley Nuttall clients are all invested according to their risk capacity and financial need using diversified portfolios that have in excess of 8,000 underlying investments.
- We have a long-term objective: Have you ever found yourself chasing a hot stock, or investing based on a magazine article or a tip from a friend? Many people invest in this way to find not only that they are no better off, but often much worse off than if they’d stayed the course. At Bradley Nuttall, we invest with the aim of achieving real, long-term wealth creation for our clients.
The BNL Investment Management Committee
We are committed to evaluating and enhancing our investment solution. Finance is a developing science and Bradley Nuttall will continue to use that evolving science in order to improve the portfolios of our clients.
Our investment management solution is formally evaluated every two months by the Bradley Nuttall Investment Management Committee, to ensure our clients achieve the results they expect and to determine what might be improved.
The objectives of the Investment Management Committee can be summarised in three ways:
a. Are our portfolios consistent with the current tax and regulatory environment?
b. Are any new investments available that offer increased diversification, enhanced asset class management, lower cost, or better risk-factor optimised characteristics?
a. What is our performance, relative to benchmark?
b. Are there any corporate actions or other issues that require attention?
a. What is the latest research on portfolio management telling us?
The Investment Managment Committee sources research from:
- Asset Class Investors Group (ACIG) – This group formally meets twice a year and comprises two New Zealand firms and seven Australian firms. The group manages in excess of $3.5 Billion and has an investment committee that peer reviews asset allocation, benchmarking, and risk return optimisations
- Consulting actuaries
- Dimensional Fund Advisers (DFA)
- Various share brokers – primarily First NZ Capital Securities, ASB Securities and Direct Broking
Selecting Appropriate Investments
At Bradley Nuttall we construct portfolios based on our key principles. Investments in our portfolios must adhere to the following key criteria:
- The investment must be low cost: In the long term, low cost investments perform better than high cost investments. This is supported by nearly every academic study on the subject. One of the most recent of these studies was carried out by Morningstar. The Morningstar Director of Fund Research, Russell Kinnel, observed that “In every single time period and data point tested, low-cost funds beat high cost funds.”
That sounds fairly conclusive. Perhaps everything you need to know about managed funds is shown on this napkin:
In the graph below you can see a comparison of managed funds costs between the average New Zealand Managed Fund and funds used by Bradley Nuttall:
- The investment must not speculate. A speculative investment is one in which a winner must be offset by a loser. For example, if a poker player wins a hand in a casino, he or she only “wins” what others have “lost.” And inevitably, the casino takes a cut for arranging the game. The same is true with investment speculators in their approaches to portfolio management. They try to beat the market by trading with other participants who are also trying to beat the market. Both parties pay to do this, but only one side in any trade will achieve that goal. In other words, they participate in a zero-sum game (relative to the market), minus costs. What makes this even worse is that the winners in one trade aren’t consistently the winners in the next trade. Given enough time, practically everyone underperforms the market, which might be compared to the adage “the casino always wins.”
- The investment must diversify our risk exposure: Diversified portfolios provide greater return at less risk than non-diversified portfolios. Risk is the source of investment returns, but the best portfolios are constructed of different types of risk. The risks facing the New Zealand economy are different than those facing the European Bond Market and different again to the risks of Canadian shares. Bradley Nuttall selects investments that increase diversification and lower the risks to our clients.
Which Risks Pay
While we have asserted that risk is the source of return, not all risks pay the same. Thanks to the work of economists Eugene Fama and Kenneth French, we now understand there are three factors that explain about 90 to 95% of investment returns. These are:
- Market Risk: This is the risk of capitalism that affects all businesses including political stability, interest rates, credit availability, etc. In other words, market risk is not business specific risk. For example, it does not address the risk that Microsoft faces competing with Apple, or that Westpac faces competing with Kiwi Bank. Business specific risk can be diversified by simply owning shares in all businesses. To put it simply, you don’t care which business wins, as long as “business” is “winning”. Because business specific risk is diversifiable, there are no additional expected returns for holding it. Market risk cannot be diversified and thus investors are compensated for holding it. This conclusion helped Bill Sharpe a Nobel Prize in 1990.
- Size Risk: This is the risk associated with small businesses. Small businesses must pay potential investors higher rates of return because they are more likely to fail. However, because these businesses are small they enjoy a greater upside if they succeed. We measure size risk using market cap. Market cap is the total value of a firm’s shares.
- Value Risk: This is the risk associated with businesses that appear to have poorer prospects, or are out-of-favour with investors. To raise capital, these out-of-favour businesses must offer investors higher returns because investors are not convinced of their long term profitability. However, since these businesses are out-of-favour, there is a greater upside if they turn their businesses around. Value risk is measured using book-to-market ratio (BtM). The BtM tells us the ratio of the firm’s accounting value to the market value of the business (its market cap). Out-of-favour firms are termed “value” and in-favour firms are termed “growth”.
In summary, the greater a portfolio’s exposure to market, size, and value risk factors, the higher its expected returns.
This is illustrated by the following chart. The total market is the intersection between small and large shares and growth and value shares:
As you can see below, the greater a portfolio’s weighting to small and value risk factors, the higher its expected returns:
The evidence for the higher expected returns of value and growth companies was laid out in a paper published by Eugene Fama and Kenneth French in 1992 in the Journal of Finance called, “The Cross-Section of Expected Stock Returns” and in another paper, “Value versus Growth: The International Evidence, ” also published in the Journal of Finance, in 1998. The differences in returns can be seen easily by viewing the annualised compound returns for small companies, value companies, all companies (total market), and growth companies in US, international, and emerging economies.
Below is a list of the main investments used in our portfolios:
|Bradley Nuttall Asset Classes||Description||Fee|
|New Zealand Equity||The NZX 50 Portfolio Index Fund (FONZ) comprises a diversified portfolio of shares in the fifty largest companies listed on the New Zealand Stock Exchange. Some clients invest directly in New Zealand equities in order to achieve a greater small and value tilt.||0.28%|
|New Zealand Real Estate||The BNL New Zealand property strategy provides broad exposure to New Zealand commercial property by investing in listed property entities.||N/A|
|Australian Large Cap||The DFA Australian Large Trust invests in Large Australian companies listed on the S&P / ASX 100 Index.||0.18%|
|Australian Value||The DFA Australian Value Trust invests in value companies in Australia listed on the S&P / ASX 300 Index.||0.30%|
|Australian Small Cap||The DFA Australian Small Trust invests in smaller Australian companies outside the top S&P / ASX 100.||0.50%|
|Global Core||The DFA Global Core Equity Trust (hedged to NZD) invests in international equities in developed markets, with a higher exposure to small and value companies relative to the market.||0.34%|
|Global Value||The DFA Global Core Value Trust invests in international equities in developed markets, with a higher exposure to value companies relative to Global Core Fund.||0.40%|
|Global Real Estate||The DFA Global Real Estate Trust invests in a diversified pool of listed Real Estate Investment Trusts (REITs) and REIT-like entities globally.||0.35%|
|Emerging Markets||The DFA Emerging Markets Trust invests in value companies in emerging markets around the world.||0.60%|
|International Fixed Interest||The DFA Diversified Fixed Interest Trust (hedged to NZD) invests in high credit quality (AA or above from Standard & Poor’s) international fixed interest investments of terms up to five years.||0.25%|
|New Zealand Fixed Income||The Harbour NZ Corporate Bond Fund and AMP NZ Fixed Interest Fund invests primarily in investment grade securities, to achieve a quarterly income stream and steady capital growth.||0.60%|
Constructing Diversified Portfolios
The essence of proper investment management is assembling a large number of low correlated assets. In other words, you want to hold investments that (to the greatest extent possible) do not rise and fall together.
Bradley Nuttall portfolios comprise over 8,000 underlying investments from:
- 23 developed economies, such as North America, Europe, Japan, and Australia
- 18 emerging economies, such as China, India, Brazil, and Eastern Europe
- All global business sectors, from healthcare to manufacturing, from commodities to financials etc.
New Zealand represents less than 0.05% of the world economy. Visually speaking, if each country’s size on the chart below represented their contribution to the global economy, New Zealand would be represented by the dot next to the grey arrow:
Portfolio construction should be considered paramount by any investor. Based on a study he carried out, Roger Ibbotson, of Ibbotson Associates, states: “We can extrapolate from the study that for the long-term individual who maintains a consistent asset allocation and leans toward index funds, asset allocation determines about 100% of performance.”
Another academic study asserts that asset allocation alone accounts for 100% of a portfolio’s total return on average.
Investment management using intelligent portfolio design enables Bradley Nuttall to simultaneously reduce your risk and increase your expected return relative to holding any one individual investment.
We hold assets in weights that offer our clients a greater expected risk/return trade-off than would be provided by investing in the New Zealand share market alone.
As can be seen above, Bradley Nuttall has eight investment managment portfolios to address the variety of client risk and return needs. In each investment management portfolio, the first number is the allocation to equities (or high risk assets) and the second number is the allocation to debt (or low risk assets). So, for example, the BNL Investment Management Portfolio 20/80 is 20% Equity and 80% Debt.
The chart below shows the broad asset allocation for the BNL Investment Management Portfolios. The blue band represents the low-risk assets of Fixed Income and Cash, while the brown, green, and yellow bands represent high-risk assets of equities and real estate.
The chart below represents the specific asset allocation for our BNL Investment Management Portfolios.
|Bradley Nuttall Asset Classes||20/80||30/70||40/60||50/50||60/40||70/30||80/20||90/10|
|New Zealand Equity (%)||3||5||6||8||10||11||13||15|
|New Zealand Real Estate (%)||3||3.5||4||5||6||7||7||7|
|Australian Large Cap (%)||0.9||1.5||1.8||2.4||3||3.3||3.9||4.5|
|Australian Value (%)||1.5||2.5||3||4||5||5.5||6.5||7.5|
|Australian Small Cap (%)||0.6||1||1.2||1.6||2||2.2||2.6||3|
|Global Core (%)||5||7.5||11||13.5||16||19.5||22||25|
|Global Value (%)||2.7||4.05||5.94||7.29||8.64||10.53||11.88||13.5|
|Global Real Estate (%)||1.0||1.5||2||2||2.5||3||3||3|
|Emerging Markets (%)||1.6||2.4||3.52||4.32||5.12||6.24||7.04||8|
|International Fixed Income (%)||48.75||42.5||36.25||30||23.75||17.5||11.25||5|
|New Zealand Fixed Income (%)||29.25||25.5||21.75||18||14.25||10.5||6.75||3|
Which Portfolio Is Right For You?
But which portfolio should you choose? This is a highly important question and one that Bradley Nuttall considers carefully for each and every client. Important considerations include:
- Do you have the income and wealth to ride our short-term market movements?
- What are your preferences for when you begin using your wealth?
- How much of your portfolio would you like to spend each year?
- Do you feel comfortable with the idea of losing portfolio value over the short-term in order to grow more wealth in the long-term?
- Do you have the investment knowledge to remain disciplined in good and bad markets?
The first step in proper investment management and risk assessment is to determine the level of risk a client has the capacity to bear. There are five broad dimensions of risk capacity:
Once we know what level of risk you can handle, we will evaluate that portfolio in terms of your needs. Certain clients go through a comprehensive needs analysis where we address questions such as:
- What are your goals, dreams, and aspirations?
- How can your portfolio help you achieve those goals?
- What actions are necessary now to prepare for your future?
- How much income per year can you comfortably take out of your portfolio?
This analysis is about you and how your investment management portfolio needs to work to serve your interests. It is during this process that our expert advisers will help you form a vision of what you can achieve, and just what it will take to get there.
Regular Review and Rebalancing
Regular reviews of your investment management portfolio not only lead to higher returns, but also ensure that your portfolio remains the best fit for you.
Your circumstances, investment experience, risk and return objectives, and financial constraints change over time. Regular reviews ensure that this information is updated as it changes. This allows us to help you stay the course and make adjustments as necessary.
Even the best investment management strategy will need to be adjusted to stay on track. To ensure your portfolio continues to offer you the highest probability of success, we will rebalance your investment management portfolio as required.
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