While diversification is important, establishing an optimal investment portfolio requires more than simply acquiring a wide spread of different assets. To be truly effective, the selection of investments in your portfolio also needs to be tailored to take into account your specific risk profile, financial objectives and investment horizon. It takes a thoughtful approach to asset allocation.

Different asset classes have different risk/return profiles. Shares tend to outperform other asset classes over the long run, but their performance can be more volatile. Conversely, bonds generally provide more steady expected returns but more limited capital growth over the long term. From a global perspective, the fast-growing dynamics of emerging markets (such as Brazil and India) can offer opportunities for strong expected returns but with more variability than the lower risk, steadier growth opportunities in more developed but stable economies (such as Australia).

The optimal blend of assets for your portfolio will depend largely on your profile as an investor. A range of factors, such as your willingness to tolerate risk to achieve investment gains, your financial circumstances, ability to weather losses, your age and the length of time you are prepared to invest, all influence the type of assets which best correspond to your specific profile and objectives. For example, if you have a longer investment horizon and are willing to endure some volatility in returns, you will generally be suited to portfolios which are weighted more heavily towards shares and property. If you’re an older investor with a higher need to avoid capital losses, you might be better suited to a portfolio weighted towards bonds and cash.

There isn’t just one optimal portfolio. In fact, for every level of return, there is one portfolio that offers the lowest possible risk, and for every level of risk, there is a portfolio that offers the highest return. These combinations can be represented graphically on a risk/return graph- and the resulting curve is known as the ‘Efficient Frontier’.

Portfolios lying on the ‘Efficient Frontier’ represent the best possible combination of expected return/risk. Your position on the frontier will be determined by the maximum level of risk that you are willing to take on.

We use a sophisticated evaluation and assessment process to match your risk profile with a recommended asset allocation strategy. Your recommended allocation will comprise a mix of growth and defensive asset classes including:

  • Australian shares;
  • International shares (hedged and unhedged);
  • Emerging market shares;
  • Infrastructure;
  • Listed property;
  • Bonds/fixed income; and
  • High-interest cash deposits.

These will be in proportions adapted to reflect your own risk profile and investment goals as well as the current investing environment.

We use a technique known as mean-variance optimisation to help find your optimal portfolio. This is a complex calculation, which analyses the way in which individual asset classes perform (i.e. how much they return – and how volatile those returns are) and how that performance compares to other asset classes (i.e. how closely correlated their performances are). We can then blend different asset classes (especially those which tend to move in opposite directions to one another) to maximize performance whilst also reducing overall risk. We use this technique as the foundation for determining the allocation of asset classes across each of our portfolios

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