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Our Portfolio Styles: Investment Plans

March 24th 2017

The investment style for complex needs. Tailor your investment strategy to your risk appetite, patience and investment horizon.

This article is the second of a 3 Part series describing our Portfolio Management Styles. We hope this provides additional transparency and helps you better understand our offering. You can read about it in more detail in our whitepaper and check our Investors Corner at any point to access videos and quotes from experts.

One of the big advantages of ETFs is that they provide complete transparency in what you own. Similarly, from our whitepaper to our continued writing on how we manage your money, our aim has always been to be as transparent as possible in how our portfolios work for you. Previously we wrote about the differences between our three services. In this piece, we wanted to focus specifically on our Investment Plans. We feel it is important that you not only select the right service and risk profile, but also have a good understanding of how your portfolio will react with this service under different market conditions.

As mentioned before, investment plan portfolios allow you to effectively tell your portfolio manager (our Platform) how you would like your money to be managed. This is done with three parameters. Firstly, the exposure setting determines how much risk in the portfolio (equities vs. bonds) you would like to have. Secondly, the patience setting tells the system how far in the past it should look to determine asset class returns, volatility and correlations. Longer time series and more history, all else being equal, mean smoother numbers and less variability. Shorter time series on the other hand tend to have greater variability. Lastly, the time horizon of your goal determines the ability your portfolio has to take risk. Longer time horizons, all else equals, tend to indicate a greater ability to take risk and a higher equity over bond allocation.

These three metrics are fed into our system in order to reach a specific combination of assets (the asset allocation) that result in a portfolio with the highest return per unit of risk. This is what is known as a point on the efficient frontier. The important thing to note is that, on a weekly basis, as we feed in new data into our system, your portfolio’s asset allocation will dynamically adjust, based on your three settings. Therefore your patience setting will determine the asset class history that should be used, whilst your exposure setting and time horizon will determine what level of risk should be optimised for. This will then deliver an asset allocation that results in a portfolio on the mentioned efficient frontier. These dynamic adjustments mean that two otherwise identical goals started at different times will have different allocations, because the asset allocation will be completely personalised by the client’s settings.

Your preferences can result in non-intuitive asset allocations under different market conditions.

If all of this is familiar to you, then we have so far done a good job in effectively communicating how our investment plans work. What we wanted to further delve into is how your preferences can result in non-intuitive asset allocations under different market conditions.

Historically, increased risk in a portfolio has typically meant a larger combination of equities over bonds. The higher allocation to equities, the higher potential levels of return and risk a portfolio tends to have. However, over the near and in some instances medium term, returns, correlations and volatility of different asset classes can shift significantly.

From a practical standpoint, what this means is that from one week to the next the asset class history used (your patience setting) could result in one asset class having more favourable expected return and risk characteristics over another. This means that to optimise for a point on the efficient frontier the combinations of assets could shift significantly from one week to the next and also result in large allocations to one asset class over another.

As mentioned, the longer your patience setting and asset class history used, the less variability there tends to be in these relationships. The way your portfolio is managed (Modern Portfolio Theory) can and often does generate non-intuitive asset allocations. You should expect to see changes in the combinations of asset classes that shift over time. You should also expect to see, in some instances, large shifts from and large allocations to one asset class over another as the system optimises for the point on the efficient frontier you have deemed suits your risk profile. The important thing is to ensure that a portfolio matches your long-term risk profile. If the portfolio does not do so, you can change your patience and exposure settings at any time, or switch your portfolio style to Starter.

Have a look at how an Investment Plan responds over time.

ETFmatic Investment Plan: Simplified simulation 10 year goal.
Dynamic target Target level of risk Bonds 50% Stocks In the beginning, bonds are strong but the capacity to handle a high exposure is greater. Target percentages are always changing in order to maintain a constant exposure level. The closer to the fund-withdrawal date, the lower the exposure.

Investment Plans allow you to tailor your investment strategy to your risk appetite, patience and investment horizon. Nevertheless, you can always switch your portfolio style to Starter or Custom.