A substantiated approach to investment management

The ultimate goal of BNL Investment Management is to give our clients that give the greatest probability of achieving their goals and financial objectives. In this section we briefly summarize the Bradley Nuttall Investment Management Process and underlying portfolios. We’ve organized the information into easy to read subsections. Click in a subsection to go directly there.

Investment Managment First Principles

1. Risk: This is the amount of volatility of returns in your portfolio measured by standard deviation. For example, if you own a high-risk portfolio it will go up fast in good markets and down 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, just the opposite is true. Your portfolio’s value goes up at steadier but slower pace and is more insulated from down movements.
2. Return: This is ultimately the rate of growth 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 returns and low risks, this trade off in the long-run is not achievable. The fastest way to find an investment charlatan (con-man) is to listen for them offering high returns with low risks.
The question is then; for any amount of risk you may want to take, how do you achieve the highest returns?

The answer? …Diversification and exposure to the types of risk that compensate investors with higher returns. Below we attempt to further explain both these concepts… first though the evidence that this academically proven methodology works.

The chart below shows the risks and returns of Bradley Nuttall (BNL) investment management portfolios over 20 years from 1991 – 2010 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 advisor and custodial fees. The NZSX 50 Index has no fee.

As the scatter plot above shows, higher risk portfolios (as shown on the horizontal axis) lead to higher returns (as shown on 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 but employ financial science to identify those risk factors that lead to better investment outcomes.

How We Manage Wealth

1. 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 manage our clients’ wealth with their goals and dreams firmly in focus.
2. 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 when we serve our clients. We have one goal, which is to help our clients achieve their goals. 
3. 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 are critical questions 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. 
4. 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 invest in just this way only to find that they are no better off, and often much worse off than if they’d stayed the course. At Bradley Nuttall we invest with the objective of achieving long-term real results for our clients.

The BNL Investment Management Committee

1. Development:
   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?
2. Maintenance:
   a.  What is our performance relative to benchmark?
   b.  Are there any corporate actions and other issues that require attention? 
3. Review:
   a.  What is the latest research on portfolio management telling us?

• Asset Class Investors Group (ACIG) - This group formally meets twice a year and consists of 2 New Zealand firms and 7 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 optimizations
• Consulting actuaries
• Dimensional Fund Advisers (DFA)
• Morningstar, (and)
• Various share brokers, although 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:

1. The investment must be low cost: Low cost investments do better in the long term than high cost investments. This is the finding of nearly every academic study on the subject. One of the most recent was done by Morningstar. The Morningstar Director of Fund Research, Russell Kinnel, observed, “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 contained on this napkin:
   
   Below you see a comparison of managed funds costs between the average New Zealand Managed Fund and funds used by Bradley Nuttall.
   
   
2. The investment must not speculate. A speculative investment is one in which a winner must be offset by a loser. For example in a casino, if poker players win a hand, they merely “win” what others have “lost.” And inevitably the casino takes a small cut for arranging the game. The same is true with investment speculators in their approach to portfolio management. They try to beat the market by trading with other participants also trying to beat the market. They both 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’s worse, the winners in one trade aren’t consistently the winners in the next trade. Given enough time, practically everyone underperforms the market, similar to the adage “the casino always wins.”
3. The investment must diversify our risk exposure: Diversified portfolios provides 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 are 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

1. 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 include 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. In other words 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.
2. 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 have greater upside if they succeed. We measure size risk using market cap. Market cap is the total value of the firm’s shares.
3. 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 about their long term profitability. However, since these businesses are out-of-favour, they have 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.

The chart below illustrates this. The total market is the intersection between small and large shares and growth and value shares.

As shown 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 the Journal of Finance 1992 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 1998. The differences in returns can be easily seen by viewing the annualized compound returns for small companies, value companies, all companies (total market), and growth companies in US, international, and emerging economies.

Below we list the main investments used in our portfolios. Click on the link to be taken to the fact sheet for each investment;

Constructing Diversified Portfolios

The essence of proper investment management is assembling a large number of poorly imperfectly 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 include 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

New Zealand represents less than 0.05% of the world economy. Visually speaking, if each country's size represented their contribution of the global economy, New Zealand would be represented by the dot next to the green arrow.

Portfolio construction should be considered paramount by any investor. Roger Ibbotson, of Ibbotson Associates, writes “[w]e 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 managment using intelligent portfolio design allows 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 is provided by investing in the New Zealand share market alone.

As can be seen above, Bradley Nuttall has eight (8) investment managment portfolios to address the variety of client risk and return needs. Click the links to below to see our Portfolio Pages. 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.

BNL Investment Management Portfolio 20/80: Defensive
BNL Investment Management Portfolio 30/70: Conservative
BNL Investment Management Portfolio 40/60: Moderate
BNL Investment Management Portfolio 50/50: Balanced
BNL Investment Management Portfolio 60/40: Moderately Aggressive
BNL Investment Management Portfolio 70/30: Aggressive
BNL Investment Management Portfolio 80/20: Highly Aggressive
BNL Investment Management Portfolio 90/10: Most Aggressive

The chart below shows the broad asset allocation for the BNLInvestment 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.

Which Portfolio Is Right For You?

• 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 growth more wealth in the long-term?
• Do you have the investment knowledge to keep disciplined in good and bad markets?

The first step in proper investment management and risk assessment is to determine the amount of risk a client has the capacity to bear. There are five (5) broad dimensions of risk capacity:

Bradley Nuttall has developed a comprehensive risk capacity survey that matches clients’ characteristics in each of these areas to an overall investment management portfolio.

Click here to measure your risk capacity.

An expert Bradley Nuttall adviser will review your survey to determine that all questions were answered accurately and comprehensively. We will then use the score as a guide to develop your actual investment management portfolio allocation.

Needs Assessment

• 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 can you comfortably take a year out of your portfolio?

Regular Review and Rebalancing

Regular reviews of your investment management portfolio lead to higher returns and ensure that your portfolio remains best fit for you.

Even the best investment management strategy needs to be adjusted to stay on track. To ensure your portfolio continues to provide you with the highest probability of success we rebalance your investment management portfolio as required.