Creating a Diversified Portfolio: Beyond the Pursuit of Returns

Discussions about investments, whether they occur at a braai, during dinner, or with a financial expert, often center on growth, returns, and performance.

However, in a truly bottom-up portfolio construction approach, discussions regarding returns would likely be considered the least significant between an individual and their advisor.

Moreover, given the plethora of investment options available in the last twenty years, the traditional 60/40 equities-to-bonds portfolio allocation is increasingly irrelevant and unhelpful.

According to Paul Counihan, MD of Wealth and Investments at Fedgroup, aside from tax optimization, there are three primary themes in a portfolio: “The first is income, the second is an asset-liability matching strategy—what assets do I need now to meet my future liabilities—and the last is a growth methodology aimed at seeking alpha.”

“Organizing these needs-driven ‘buckets’ enables advisors to remove emotional factors from the investing process, which is a foolproof method for creating a solid portfolio. Each decision in this framework is highly independent and crucial.”

“The first question I pose to clients is ‘What income do you need to generate?’ Then, we reverse engineer that,” Counihan explains.

“We look at ‘Here are the most efficient options for generating your required income. What percentage of your savings should we allocate to that strategy?’”

For the next ‘bucket,’ Counihan notes the question requires a lot of context regarding the investor’s life stage, as these funds must correspond to commitments the investor has over the next two, three, four, or five years.

“We cannot afford the risk that, for instance, that million rand is not accessible in five years,” he adds.

This could involve anything from funding a child’s tertiary education to a planned asset acquisition, each requiring a distinct investment approach.

The final ‘bucket’ is the more traditional return or alpha-focused segment, which often overshadows the other two critical components.

Even in this area, Counihan emphasizes the importance of considering each client’s unique risk tolerance, ability, and investment timeline. However, because the other needs are addressed in the portfolio, one can afford to make bolder choices here, he suggests.

“It’s evident that the conventional growth portfolio is now, in some respects, the last aspect you consider when constructing an individual’s portfolio because you have these diverse themes and life needs that extend beyond mere growth.”

Rethinking capital preservation

Counihan mentions that traditional asset classes and investment products often fail to meet the needs of that second bucket, and there is a tendency to rely on generic income options.

“Options for your preservation and income buckets have been somewhat dull and linear. Gone are the days when a bank fixed deposit was the go-to option for capital preservation.”

Even the alternative of utilizing income-focused unit trusts is not optimal, as selling units to access income can activate capital gains tax.

“Fedgroup has effectively carved out a solid niche in this non-alpha-focused realm,” says Counihan.

It has achieved this over more than 35 years by leveraging the rise of private capital and alternative asset classes. Consider secured debt instruments in energy and agriculture, rather than speculative ventures like crypto or art. These strategies have consistently generated returns.

To ensure stability and predictability in the initial two buckets (income and capital preservation), the firm offers a variety of endowments, its Secured Investment (a collective investment scheme participation bond), and unit trusts “that provide investors with the peace of mind they seek.”

Crucially, this stability should not be confused with excessive caution.

“All these products are tailored to safeguard capital,” Counihan remarks.

“We also present options that enable investors to utilize these investments within tax-efficient wrappers or outside of them,” he continues, noting that not all options fit every investor’s situation.

By employing this methodology for portfolio construction, the headline return is arguably less significant precisely because it guarantees that three distinct functions are being correctly addressed.

“Rather than fixating on returns, the focus shifts to the planning, the bucketing, and the segmentation of how investments fulfill the client’s life needs. That’s what truly matters.”

Brought to you by Fedgroup.

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