In an AFR summer series, investment experts give us their thoughts on the year ahead - and how they unwind. Olivia Engel, head of active quantitative equity in Asia-Pacific for State Street Global Advisors, highlights the importance of building a portfolio that can handle these uncertain times.
How do you construct your portfolios and what can retail investors learn from this?
Portfolio construction is just as important as stock selection. We all know diversification is crucial and while investors may think they have a good spread of equity investments to protect them in a downturn, many actually don't. We're a bit different at SSGA in that that we build "benchmark unaware" portfolios - meaning we don't use a benchmark index such as the S&P/ASX 200 as our starting point. Other funds, even though they say they're active, can end up looking very similar to the index. We choose companies with high expected returns but we are also careful to consider the expected volatility path of the stocks we choose as a portfolio.
Uncorrelated positions help to lower overall portfolio volatility. Stock positions contribute to exposure to various themes and it's important to see what theme is emerging from the collective portfolio of stocks. For example, the four major Australian banks are exposed to the same theme and are highly correlated -when constructing portfolios, we consider whether this theme is something we want to dominate the overall portfolio. I would encourage retail investors to consider the whole portfolio impact of their stock picking to determine whether their ·positions are correlated with one another or tied to one particular economic theme.
What should investors focus on in the current environment?
We are entering a monetary policy inflection point that could last more than a year or two. We're seeing a bottoming of the global interest rate cycle, with a huge degree of uncertainty as to when and how quickly it will change direction. We don't try to forecast the direction of interest rates, commodity prices and GDP, but instead focus on selecting companies that can reliably deliver steady earnings and are not over valued.
What behavioural biases should retail investors be aware of?
There are so many behavioural biases that can stop us from making good decisions with our investments. Some of the most notable traps include confirmation bias (seeking out information that confirms prior beliefs and ignoring contradictory information), loss aversion and the disposition effect (hastily selling assets whose price has increased while retaining for too long assets that have dropped in value), the endowment effect (valuing an asset more when it is held) and regret aversion (avoiding an action for fear of making a poor choice). Being aware of these biases goes a long way towards not falling prey to them. Having a well-defined process around how stocks are bought and sold helps too.
What's been your best (personal) investment?
It's hard to separate financial investments from other types of investments. For example, I invested time and money in my own tertiary and professional education to increase the value of my human capital. That was of greater benefit to me than any security or financial investment I attribute many of my career leg-ups to the qualification I received, the network I built up and the leadership experience I found from undertaking the CFA Program which l completed in 2000 - it was a significant undertaking. My main financial investments have been my superannuation assets, my home, and investing in the equity funds managed by my team at SSGA. Judging the success of my investments will depend on whether my financial objectives are met, not necessarily the one with the highest absolute return. I'm still in accumulation phase so it's hard to judge which one will contribute most to my financial security when I need to draw down on those assets. I think investing additional funds into equities during the global financial crisis at the end of 2008 was probably the best long-term investment I've made so far. It didn't feel good at the time, though.
What's been your worst (personal) investment?
The first house I bought with my husband in our mid-20s was advertised with a caption which read: "What a Shocker". It was indeed a "renovator's delight". While we made a decent sum on the capital value of the house over five years or so before we needed something bigger, the worst investment we made was commissioning an architect with grand plans to gut and renovate the place.