Individual investors can learn some valuable lessons from how heavyweight institutional investors construct and manage their multi-billion-dollar portfolios.
No matter the size of an investment portfolio, factors that really matter for both institutional and individual investors include: setting of appropriate investment objectives, setting an appropriate strategic asset allocation, minimising costs, remaining disciplined and periodically rebalancing a portfolio.
Vanguard in the US has just released a research paper, A framework for institutional portfolio construction, highlighting the importance of these fundamentals of sound investment practice for institutional investors.
Interestingly, a Vanguard research commentary* published in 2013 had specifically looked at lessons that institutional investors might have for individual investors. It stressed that while institutional investors can have different objectives and challenges to individual investors, "more striking than the differences, however, are some of the similarities".
Vanguard’s most recent research paper on the construction of institutional portfolios includes the following points for institutional investors that individual investors may want to keep in mind when creating and maintaining their own much-smaller portfolios:
Set your investment objectives. This applies whether the investor is, say, a large superannuation fund, an insurance company, university or an individual. What do you want to achieve with your portfolio?
Set your portfolio’s strategic or target asset allocation. The paper emphasises that an investor’s strategic asset allocation – its intended diversification between asset classes – is the "crucial driver" of diversified portfolio returns. (And it points to research of all-available balanced funds in Australia, the US, Canada and the UK showing that between 80 and 92 per cent of variable returns over at least 20 years to December 2011 were attributable to asset allocation – not timing or security selection.)
Determine your investment approach for creating a diversified portfolio. The paper describes market-cap-weighted indexes, tracked by index funds, as the "cornerstone" of a strategic asset allocation because of their low cost, liquidity and exposure to the whole market. And it refers to research, discussed by Smart Investing from time to time, showing how the average active manager underperformed its benchmarks. (See The case for index fund investing in Australia.) The Vanguard paper on institutional investing does acknowledge that active investment management has shown some evidence of success attributable to talent, low cost and patience through inevitable periods of underperformance.
Minimise investment management costs. "Regardless of the strategy, the odds of success increase when costs are low and discipline is high," the authors emphasise.
Maintain a disciplined approach. "Having the discipline to stay with a plan over the long run, to rebalance when necessary, and to adjust strategies only infrequently is critical to long-term achievement," they conclude.
Informed individual investors – perhaps with the guidance of an adviser – are well positioned to create and maintain investment portfolios that truly reflect their personal circumstances. These circumstances include their particular goals, tolerance to risk and investment timeframe.
* Finding wider lessons in how institutions invest, Vanguard Centre for Retirement Research. 2013.
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Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment. |
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