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The ‘most valuable player’ of investing

Stuart Fechner
— 1 minute read

With football finals and awards season almost upon us, it is worth considering what it would take to win a ‘most valuable player’ award for investment, writes Bennelong Funds Managements Stuart Fechner.

No matter who you follow, this is the time when footy fever reaches peak levels in Australia, with the NRL and AFL grand finals upon us.

It’s also awards season, with both codes deciding on the most valuable player (MVP) for the season. This is an award that is not necessarily given to the ‘best’ player, but rather the one who has best fulfilled a particular role or purpose that has clearly contributed to their team’s overall success.

In an economic sense, how can you determine the MVP of investment funds – let’s say in relation to a range of Australian equity funds that sit within a broader portfolio?

The first thing to do is determine what success is going to look like to the investor.

It’s safe to assume investors want their portfolio to provide an optimal outcome of risk-adjusted returns. Yet that’s an equation that was solved for a specific outcome – in this case, a particular risk/return trade-off.

However, just like footy teams, investors don’t have one single outcome or need. A mix of things are important to each individual. Money may be needed to cover short-term liabilities that are non-negotiable. Others may have a longer-term objective, such as a holiday fund or a new car.

These are personal needs and wants, and clearly have no direct relationship to any theory-based risk/return process. They also can’t always be solved by a process that has a single outcome. Multiple objectives require multiple strategies.

Returning to Australian equities, let’s consider three items of importance to an investor.

Price sensitivity

Regardless of the product, people understand price. Some feel that paying more is worth it to get the good stuff. Others don’t see the value in paying any more than the ‘average’ price of a product.

In terms of portfolio construction, if price sensitivity is a key driver for an investor, it’s likely that a reasonable allocation to low-cost and/or index funds is required. They may not be the highest-performing investments in the market, but they meet that particular investor’s price requirements.

Higher returns than the market

To provide an opportunity to outperform the market, an actively managed fund is required.

Some funds are more active, concentrated or differentiated from the market or index than others. Investors might also prefer an allocation to a specialised fund within the Australian equities sector – a medium/small cap investment fund, a long-short fund or a dedicated sector fund.

Minimising capital loss when markets go down

Let’s refer to this as the ‘sleep at night’ factor. No-one likes watching their investments go backwards, but it hurts some people more than others. Understanding an investor’s response to negative returns is key, yet unfortunately is almost impossible to measure. There’s no formula or theory that tells us how a person feels when they see their balance dropping.

Some funds include minimising negative returns (i.e. protecting capital) as a clear component of the overall investment strategy. Such funds are rarely at the top of performance tables when markets are performing solidly, but if they hold up well when markets are negative it’s a good outcome for those investors who want to ‘sleep at night’.

In a football sense, players play different roles within the team. When determining an MVP, how do you assess the players involved? In a chain of possessions that starts at the centre and ends in a try or goal, they all play an important role.

So who wins the fund MVP award?

It all comes down to what is most important to the end investor. Different funds are needed for both diversification and to play a part in the overall risk/return outcome of a portfolio through investment cycles, but as people with emotions and behavioural biases, we react differently to the same events.

The fund that plays the most important role to an individual investor, based on what matters most to them, could then be judged as the MVP.

Stuart Fechner is the director of research relationships at Bennelong Funds Management.

 

The ‘most valuable player’ of investing
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