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27px;padding-bottom: 54px;"> <!--[if (gte mso 9)|(IE)]> <table align="center" border="0" cellspacing="0" cellpadding="0" width="600" style="width:600px;"> <tr> <td align="center" valign="top" width="600" style="width:600px;"> <![endif]--> <table align="center" border="0" cellpadding="0" cellspacing="0" width="100%" class="templateContainer" style="border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;max-width: 600px !important;"> <tr> <td valign="top" class="bodyContainer" style="background:#transparent none no-repeat center/cover;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;background-color: #transparent;background-image: none;background-repeat: no-repeat;background-position: center;background-size: cover;border-top: 0;border-bottom: 0;padding-top: 0;padding-bottom: 0;"><table border="0" cellpadding="0" cellspacing="0" width="100%" class="mcnTextBlock" style="min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <tbody class="mcnTextBlockOuter"> <tr> <td valign="top" class="mcnTextBlockInner" style="padding-top: 9px;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <!--[if mso]> <table align="left" border="0" cellspacing="0" cellpadding="0" width="100%" style="width:100%;"> <tr> <![endif]--> <!--[if mso]> <td valign="top" width="600" style="width:600px;"> <![endif]--> <table align="left" border="0" cellpadding="0" cellspacing="0" style="max-width: 100%;min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;" width="100%" class="mcnTextContentContainer"> <tbody><tr> <td valign="top" class="mcnTextContent" style="padding-top: 0;padding-right: 18px;padding-bottom: 9px;padding-left: 18px;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;word-break: break-word;color: #5b5b5b;font-family: Helvetica;font-size: 14px;line-height: 150%;text-align: left;"> <div style="text-align: center;">EDITION 22 | JULY 2020</div> </td> </tr> </tbody></table> <!--[if mso]> </td> <![endif]--> <!--[if mso]> </tr> </table> <![endif]--> </td> </tr> </tbody> </table><table border="0" cellpadding="0" cellspacing="0" width="100%" class="mcnDividerBlock" style="min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;table-layout: fixed !important;"> <tbody class="mcnDividerBlockOuter"> <tr> <td class="mcnDividerBlockInner" style="min-width: 100%;padding: 18px 18px 32px;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <table class="mcnDividerContent" border="0" cellpadding="0" cellspacing="0" width="100%" style="min-width: 100%;border-top: 1px solid #8B8B8B;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <tbody><tr> <td style="mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <span></span> </td> </tr> </tbody></table> <!-- <td class="mcnDividerBlockInner" style="padding: 18px;"> <hr class="mcnDividerContent" style="border-bottom-color:none; border-left-color:none; border-right-color:none; border-bottom-width:0; border-left-width:0; border-right-width:0; margin-top:0; margin-right:0; margin-bottom:0; margin-left:0;" /> --> </td> </tr> </tbody> </table><table border="0" cellpadding="0" cellspacing="0" width="100%" class="mcnImageBlock" style="min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <tbody class="mcnImageBlockOuter"> <tr> <td valign="top" style="padding: 0px;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;" class="mcnImageBlockInner"> <table align="left" width="100%" border="0" cellpadding="0" cellspacing="0" class="mcnImageContentContainer" style="min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <tbody><tr> <td class="mcnImageContent" valign="top" style="padding-right: 0px;padding-left: 0px;padding-top: 0;padding-bottom: 0;text-align: center;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <img align="center" alt="" src="https://mcusercontent.com/cdd951e6a7a08b835a0f38a3f/images/9c820a85-8ecf-49ce-89c3-abf408cbc83c.jpg" width="600" style="max-width: 1200px;padding-bottom: 0;display: inline !important;vertical-align: bottom;border: 0;height: auto;outline: none;text-decoration: none;-ms-interpolation-mode: bicubic;" class="mcnImage"> </td> </tr> </tbody></table> </td> </tr> </tbody> </table><table border="0" cellpadding="0" cellspacing="0" width="100%" class="mcnTextBlock" style="min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <tbody class="mcnTextBlockOuter"> <tr> <td valign="top" class="mcnTextBlockInner" style="padding-top: 9px;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;"> <!--[if mso]> <table align="left" border="0" cellspacing="0" cellpadding="0" width="100%" style="width:100%;"> <tr> <![endif]--> <!--[if mso]> <td valign="top" width="600" style="width:600px;"> <![endif]--> <table align="left" border="0" cellpadding="0" cellspacing="0" style="max-width: 100%;min-width: 100%;border-collapse: collapse;mso-table-lspace: 0pt;mso-table-rspace: 0pt;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;" width="100%" class="mcnTextContentContainer"> <tbody><tr> <td valign="top" class="mcnTextContent" style="padding-top: 0;padding-right: 18px;padding-bottom: 9px;padding-left: 18px;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;word-break: break-word;color: #5b5b5b;font-family: Helvetica;font-size: 14px;line-height: 150%;text-align: left;"> <h4 class="null" style="display: block;margin: 0;padding: 0;color: #949494;font-family: Georgia;font-size: 20px;font-style: italic;font-weight: normal;line-height: 125%;letter-spacing: normal;text-align: left;">As a business Steward Capital have sought research partners who have the ability to identify skill in the investment space as well as the ability to manage risk. The financial planning process that we employ needs to be able to deliver predictable results. </h4> <br> This article embodies what we seek in an investment process as implemented with our research partners, Fundhouse. <br> <br> As the saying goes, ‘hindsight is 20/20’. But how do you solve the problem of building forward looking portfolios? Our portfolio construction approach has a number of layers to it to ensure that we provide clients with the greatest range of investment opportunities – after all, it is returns we are all seeking. However, this comes with an interwoven set of risks which we need to be able to identify, assess and mitigate. Some of them are also more obscure than others and have the potential to derail a financial plan. In this article we touch on the various aspects we consider when looking at how best to construct a client portfolio<br> <br> The setting of a financial plan has a key determinant to its success: the appointment of suitable investment managers to deliver on the plan’s return expectations. There are many investment alternatives, offered through an increasingly diverse and complex range of fund options in the market. As investors we can elect to go active or passive, fundamental or quantitative, we can use value managers or growth managers or some variation thereof, we can use large managers or small managers, or one of the many ‘boutiques’. This range of choice is complex and fraught with pitfalls, and can adversely affect an investor's wealth if not implemented well. So how do we go about making sure that our clients’ portfolios are the best they can be? We believe that a diversified portfolio of individual funds is the most optimal way to deliver on return requirements. To provide some context, below we show the various levels of risk management we consider when constructing portfolios:<br> <br> <img data-file-id="5317225" height="252" src="https://mcusercontent.com/cdd951e6a7a08b835a0f38a3f/images/8712388b-6f1d-4bff-bad4-4a3fc7958b06.png" style="border: 0px;width: 600px;height: 252px;margin: 0px;outline: none;text-decoration: none;-ms-interpolation-mode: bicubic;" width="600"><br> The first two risks (‘selection’) relate to the selection of various securities across the range of asset classes (equity, bond, cash, property). These are controlled by the fund manager, where a relatively high number of individual positions diversifies investors against specific problems with any individual instrument. A recent example here would be Sasol, with its cost overruns on the Lake Charles Project causing share price decline, ahead of a complete collapse in oil prices in Q1 2020. This would be offset by the 30 or 40 other securities held in a portfolio not exposed to this event. In this context equities are more diversified than securities like bonds, as they are spread across industries and regions, whereas government bonds are highly reliant on only a few factors to underpin their returns. The second set of risks relate to the way in which securities are selected (‘style’). A Value manager for instance would like to buy at low prices, whereas a growth manager would like to buy companies where future earnings growth is high. There are similar examples in the other asset classes too. Some bond managers like to buy high yield bonds, others like to be flexible around how much interest rate risk they take on.<br> <br> A property fund may anchor on yield, whereas a balanced fund may favour safety first in its process in how it derisks quicker than when it adds risk. The investment philosophy that one will often see as the shop front of the fund manager is essentially how they see the world of investment opportunity – their investment ‘style’. It is this style which helps determine how they add value to investors. The last set of risks relate to the overarching issues which we find across a fund management business (‘structural’). These types of risks are less commonly addressed by investors, but we see them as critical in assessing future investment outcomes. If an organization does not offer a pleasant working environment, it’s unlikely the fund management team stays long term. At the staff level, if the decision making culture doesn’t allow debate and challenge, will the best ideas shine through? Unlikely. More often than not, we see substantial weaknesses in the organizational structure of an investment manager, and this throws up big questions around whether or not we will get the returns we expect, when the business itself is not built on sound foundations.<br> <br> When allocating to a single fund manager, we may easily achieve the desired risk management outcome at the selection level, as most portfolios will include a basket of diversified instrument holdings. However, we will be fully exposed to both their style as well as their structural risks, and we will have no protection against problems there. It is appealing to be able to select a single fund manager to implement portfolios for clients, however the disappointment rate is likely to be high. The commonly observed issues come in various forms: styles can be out of favour (e.g. Value, for the past decade), changes to portfolio managers or teams, business profitability and sustainability, or material investment errors causing permanent capital loss. To offset these potential problems, we could then simply diversify across a range of funds. However, there are pitfalls here too: di-“worse”-ification (blending too many funds and removing the potential for value add), our own behavioural errors or responding to client pressures (buy high/sell low), and the ability to understand what it is you are investing in given we are one step removed from the management of the portfolio.<br> <br> So, what is the optimal solution? We believe that by addressing the gaps and being aware of our own limitations, we can minimize the potential risks across the spectrum for clients. What are the benefits, and how do we aim to achieve these? Know what you are buying! This relates to Risks 1 and 2 (selection). Our research process focusses on this area to identify fund managers who are likely to make consistent investment decisions which add value. Our fund ratings indicate the respective level of comfort we have, and we align portfolios towards the highest rated funds. We focus on understanding their decision making traits, behavioural biases, and their style. Diversify your style risk exposure (Risks 4 and 5). We are not value disciples, nor are we growth or quality bulls. All funds are assessed on investment merit, and we focus our efforts on identifying how the various market environments support or detract from a particular investment style. For investors, the journey is important, and for ourselves, increasing the odds of success is a significant goal.<br> <br> By way of illustration, if we consider three well rated funds across the various styles, and observe how a combination of the three far outweighs the selection of an individual:<br> <br> <img data-file-id="5317221" height="187" src="https://mcusercontent.com/cdd951e6a7a08b835a0f38a3f/images/45a4f842-38a6-410c-9cab-65faee6e0f96.png" style="border: 0px;width: 600px;height: 187px;margin: 0px;outline: none;text-decoration: none;-ms-interpolation-mode: bicubic;" width="600"><br> <br> The table shows how the blended combination provides investors with a more reliable outcome. For instance, 10 years ago would we have known it would be a poor decade for Value, as illustrated by the Dodge and Cox numbers. Or that if we needed to give our money to a single manager it should have been Baillie Gifford (recalling that at the time investors were reeling from the GFC and were highly risk averse, and may have been too conservative to make this higher risk selection). The blend results in a high aggregate return, while at the same time smoothing out the journey through lower volatility and less cyclicality relative to the market. We get the best of both worlds. This provides better risk adjusted returns as well. We can achieve this firstly by knowing what we are buying (so that we can select the funds for the blend), but also because managers think and implement differently, and this diversification passes through in the form of lower risk measures. Protect against problems within specific investment businesses or teams (Risk 5,6,7). Much of this risk is identified and managed in our research process, however there is always the potential for unforeseen issues which arise from time to time. Senior staff departures or a business merger are examples of disruptive events which can hamper the performance of a fund. We will typically avoid funds where organisational risks are high (despite the fact there may be a good fund within the business), and we will always diversify away from single business risk.<br> <br> Once we have identified and mitigated these three sets of risks, we can set about looking for good fund options. We follow a specialist approach to fund selection where we focus on understanding the nature of how investment decisions are made, including how the particular manager perceives risk. This helps guide us on a forward-looking basis rather than falling into the mental traps of using past performance as a guide. Fund management is an intellectual capital pursuit, so for us it is essential that we see these fund management teams in person on a regular basis to test their process and our understanding. Desktop research doesn’t provide the insights we need to make fund selections. These specialists allow us to build portfolios which include the broadest spectrum of investment opportunities, not just the ones that an individual manager will deem appropriate or have the capacity to manage. Examples here would be to add a specialist small cap fund, or a fund which only covers emerging markets or property. Or it might be a balanced fund with an absolute dislike for capital drawdowns. Whatever the specialization, this adds further opportunity and diversification to clients. The easiest way to detract from this process is to second guess your managers, or to lose faith when performance is weak. In this respect we have some advantages over a typical fund allocator where they don’t spend substantial time evaluating funds. For example, we are encouraged when fund managers underperform for the right reasons. Saying that, we will also become concerned when a manager’s decision-making process seems to have changed, something which can happen during times of stress or underperformance. This ability to identify, and hold, individual funds over the long term gives us an edge where we can let their individual styles run freely to add value, with the offsetting risk management embedded in the construction of portfolios ensuring that no individual fund, style, or business issue will permanently derail the ability for the investor to reach their financial goals. This approach does result in more funds within a client portfolio than you would typically expect. Provided that the fund is adding marginal benefit in the form of return potential, or risk reduction, then there should be no issue from a theoretical standpoint. From a practical perspective, investors believe less is more. We are not so sure – the investment industry changes more often than one might hope for, and when we see the opportunity to diversify business, people or behavioural risks, we will take it. We need to start with the client’s needs in mind, rather than with what the respective investment managers have put forward. The relatively minor inconvenience of longer fund lists is offset through time by better diversification and more reliable returns. <br> <br> In summary, we aim to build portfolios which give our clients every opportunity to succeed, and to remove or reduce the risks which are an unwanted hurdle in the pursuit of a good financial outcome. <br> </td> </tr> </tbody></table> <!--[if mso]> </td> <![endif]--> <!--[if mso]> </tr> </table> <![endif]--> </td> </tr> </tbody> </table></td> </tr> </table> <!--[if (gte mso 9)|(IE)]> </td> </tr> </table> <![endif]--> </td> </tr> <tr> <td align="center" valign="top" id="templateFooter" data-template-container="" style="background:#333333 none no-repeat center/cover;mso-line-height-rule: exactly;-ms-text-size-adjust: 100%;-webkit-text-size-adjust: 100%;background-color: #333333;background-image: none;background-repeat: no-repeat;background-position: center;background-size: cover;border-top: 0;border-bottom: 0;padding-top: 45px;padding-bottom: 63px;"> 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