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ADVISORY COLUMN: PERSONAL FINANCE

Oran Hall | High yields on investments don’t always mean superior performance

Published:Sunday | March 23, 2025 | 10:00 PM

It is easy to believe that the high yield of a managed personal investment portfolio or a pooled investment fund means that its performance is top-notch, but it might not be so as it might not be sustainable, or it could have been achieved by...

It is easy to believe that the high yield of a managed personal investment portfolio or a pooled investment fund means that its performance is top-notch, but it might not be so as it might not be sustainable, or it could have been achieved by taking higher-than-acceptable risks.

Asset allocation is the most important factor in the performance of an investment portfolio, and it has to align with the risk profile of the investor or group of investors. It is the responsibility of the fund manager to deliver over the long term consistent returns that are in line with the risk profile of the people whose funds they manage.

Naturally, there will be ups and downs due to market fluctuations, for example, and the fluctuations in the performance of the portfolios will reflect the level of their risk, mild fluctuations for conservative portfolios and sharp fluctuations for aggressive portfolios.

There is a reason why fund managers apply various tools to determine the risk profile of individual investors and why they create funds, in unit trusts, mutual funds, and defined contribution pension schemes like approved retirement schemes to generally match the risk profiles of various groups; they want to create the most suitable portfolios for them.

To achieve this, they create an asset mix for each investment portfolio. It is the percentage of each fund that is to be invested in the various asset classes over the long-term. In other words, it shows the weight of each asset class in the portfolio. It is, however, natural for the asset mix at any time to vary from the long-term mix as asset prices change, assets are bought and sold, and new money flows into the fund.

The types of assets and the securities under each asset class, and their proportion in relation to the full portfolio give a good indication of the objectives of the investor. Some common asset classes are money market securities, bonds, equities and real estate. The first two are best suited for capital preservation and regular income, the others, for capital appreciation, although they also generate income, dividends and rent respectively.

A conservative investor is more focused on capital preservation than capital gains, the opposite of the aggressive investor. There is another type of investor, best described as the moderate-risk investor, who tends to favour more balanced portfolios, which are not skewed to either capital preservation or capital growth.

Exposing conservative investors to riskier instruments is unjust, because, although it might sometimes give them high returns, it might yield very low returns when market conditions are unfavourable to instruments that give capital appreciation. Conservative investors do not have a stomach for high risk.

In the case of pooled funds, fund managers might be tempted to deviate from the recommended asset mix due to market competition which puts competing funds in a position in which each wants to be the top performer.

Apart from that, sharp increases in the market value of instruments like equities and real estate might cause serious distortions of the asset mix. But there is a remedy.

Strategic asset allocation – the long-term target asset mix – is the most important investment decision of the investment process, but dynamic asset allocation and tactical asset allocation are useful in the portfolio management process. Dynamic asset allocation is the periodic re-balancing of the actual portfolio weights to ensure they match the target long-term weights when some asset classes move significantly outside of the long-term asset mix.

For its part, tactical asset allocation aims to create extra value by allowing one or more asset class to vary significantly from the target long-term weights when the market causes significant beneficial changes in the prices of one or more class of assets. In time, re-balancing has to be done. How well these strategies are employed shows the mettle of fund managers.

The unit trusts and mutual funds in our market indicate the asset classes into which they invest money in published reports, but only by examining their offer documents can investors get a closer look at the instruments that they invest in. The utility of this is limited as investors cannot know if, in the case of a money market fund, for example, instruments of another asset category are included in it, or worse, occupy an outsized place in it because such information is not generally available.

The quality of a portfolio manager – meaning individual managers and portfolio management companies – can be evaluated, but it is not very meaningful to do so on a short-term basis. What really matters is the level and consistency of the returns at the investor’s level of risk.

Top-of-the class managers are able to use effective asset allocation strategies to determine the most suitable asset mix for their clients. They have a good grasp of market conditions and keep current with conditions in the local and global economies, and are able to select suitable investment instruments and make timely decisions. They keep in view the needs and objectives of the investor and make them paramount in the management of the portfolio.

Good returns over the long term suggest that a fund manager is a good performer. Generating even very high returns on a short-term basis does not. Worse, deriving good returns without adhering to the long-term asset mix, and employing assets that expose investors to risks outside of their risk tolerance are not features of a high-performing fund manager.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com