The COVID-19 pandemic has had a tremendous impact on global stock markets.
During March and April, we have witnessed acute volatility, and for many investors this has been cause for concern.
But at First Financial, our unique Investment Philosophy has helped to minimise the effect on our clients’ portfolios.
What is our Investment Philosophy?
There are two major classes of assets – defensive and growth assets. The cornerstone of our Investment Philosophy is to separate these asset types into “buckets” based on each client’s circumstances. Graeme explains,
“For all our clients, whether retirees or younger, we keep their asset classes in independent buckets. The amount in each depends on how much the client needs to draw on their assets for income in the short to medium term.
Obviously, retirees need to draw on them more readily than someone who has 20 years until they retire. They are both very different scenarios, but the fundamentals remain the same.”
We classify the first bucket as the “cash bucket” as this is where our clients draw their income from. Graeme outlines how this is structured.
“We review the client’s annual cash-flow needs and we make sure that we have six to twelve months’ worth of funds available in the bucket. We also include an added margin for safety.
For retirees, the amount in this bucket is always more because they are drawing down regularly. The general rule of thumb is that this is where we have the most liquid assets, such as cash and other assets we can access within 48 hours. This makes sure that we always have the client’s requirements in readily available cash.”
The second bucket generally contains fixed income or enhanced yield assets that see a slightly higher return than cash. Graeme continues,
“In the second bucket, we hold their one to five-year cash-flow needs. These are still defensive assets but tend to achieve around 2%–3% higher return on average when compared to cash.
They do have some drawbacks… such as, sometimes they are required to be invested for a certain term or until maturity, but we know how to plan them around a client’s cash-flow needs. The capital tends to be very secure, where at the end of the investment term, you should get all your capital back.”
The growth portion of the portfolio is held within the third bucket. And this is where we utilise our long-term forecasting to help add value. Graeme expands on this…
“Beyond the five years of cash flow, we believe the remainder of the assets can be allocated to growth assets such as property, infrastructure and shares. However, this is definitely not a set and forget. Because we’ve insulated this part of the portfolio from short-term selling risk – or forced sell – we can draw some meaningful inferences from the ten-year forecast and actually tilt the growth bucket towards assets that we think are going to do better.
It must be noted that there are still asset bubbles within growth assets. It’s not the case that they always outperform in the long term. So, we assess whether there are indications that a growth market could be in a bubble and we always try to avoid buying overpriced assets.”
Growth assets are protected
The benefit of the Investment Philosophy is that growth assets are protected. Any short-term risk is mitigated by having a sufficient allocation of defensive assets in buckets one and two to provide cash flow. This means when we have a market downturn our clients don’t have to sell their growth assets in bucket three to fund their income needs… giving their growth assets a chance to recover.
Graeme also explains how this differs from other investment models and those found in industry super funds.
“In a diversified, balanced fund where you sell down to pay your pension, you are selling units in that diversified strategy. Each time you cash in a unit you are reducing your underlying base of capital.
If you experience a savage event while you are drawing down… you end up cashing in a lot more of your shares because you are selling at lower prices. When the market recovers, you find that your capital has been decimated and you are unable to participate in the recovery because the amount of shares you now hold is far less. This is known as sequencing risk and we actively try to avoid this.
Within our Investment Philosophy, normal portfolio principles are also maintained… good diversity and asset allocation help to manage risk. There are a lot of factors that go into constructing a portfolio, but we believe this is the most reliable model and we are passionate about it.”
As part of the recent economic stimulus, the government has halved the minimum drawdown rate for account-based pensions for financial years 2019/20 and 2020/21. Primarily, this is to protect diversified fund clients so they don’t need to sell investments at a loss to fund their pension payments, as Graeme explained above. Our clients don’t necessarily need to access this benefit, as their buckets already protect them. But Graeme highlights there are possible opportunities available,
“If clients can afford to halve their pension minimums, they will have more cash available and some of our shrewd clients realise they won’t see many of these good-quality companies at these low prices again. More cash allows them to seize opportunities and they actually invest at a low point.
Clients are becoming quite savvy and see value when other people are fearful and running from the market. And while these companies will face difficulties for six to nine months, they will manage through and we are unlikely to see them trading again as cheaply as they are now.”
Graeme’s final note is,
“In the long term when things recover, portfolios that are set up aligned with our philosophy almost inevitably come through stronger.
We don’t pretend to know how deep or how long the downturn will go for… but it doesn’t really matter because our philosophy structure is built for uncertainty.”