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A footy fan's guide to portfolio construction

Bart Dowling  |  30 Sep 2013Text size  Decrease  Increase  |  

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Bart Dowling is an investment strategist with Select Asset Management.


Now that we're at the business end of the footy season, it seems appropriate that we outline our thoughts as to the similarities between portfolio construction and football.

What do these seemingly disparate pursuits have in common? Surprisingly, more than you think.

Every good football team - no matter what the code - has the right mix of "attack" and "defensive" players. So too should a well-constructed portfolio.

Ideally, a portfolio should have a number of allocations that capture positive market performance (positive "beta" as it is known in finance parlance) as well any potential upside value-add (or "alpha" as it is known) from positioning in a rising market environment. These are your attack players.

Likewise, a good portfolio should also have an appropriate mix of defensive players. These are the allocations that get you out of trouble when things go wrong and markets take a turn for the worse.

Volatility traders, long/short equity managers and gold bullion are all assets that come to mind as having good defensive qualities.

Ideally, each defensive position should have a major risk tagged to it as justification for being a member of the "portfolio team" - gold bullion defends against the threat of hyperinflation for instance, long/short equity managers defend against a free-fall in equity markets, volatility traders defend against market disruptions generally.

It is in the mitigation of these risks that your defensive players shine. But getting the right mix of "defensive" versus "attack" positions is more easily said than done.

Much has been written in the field of finance theory about optimal portfolio construction - Markowitz first wrote about Modern Portfolio Theory in the 1950s (and eventually won the Nobel Prize in Economics for his work in the area). Since then, a whole branch of finance has grown up around the concept.

In practice, getting the mix right is just as much art as it is science - mature heads know that mathematics can only take you so far in constructing a good portfolio.

Indeed, at times, in-depth experience and market intuition comes to the fore in understanding both asset behaviour and evaluating the types of risks that could beset a particular type of portfolio.

Blending a portfolio appropriately is even more important when one considers that traditionally there is a cost trade-off between defensive and attack positions.

It is often said there is "no free lunch" when it comes to financial markets. Nothing could be truer when it comes to getting a particular portfolio's defensive/attack positioning right.

How so? Well, typically a defensive position "costs" (either in an absolute or relative sense) when markets are going up - but pays handsomely when markets go into free-fall.

In short, defensive positioning will clip some of your upside performance in a rising market but will also help minimise the size of your losses when things go pear-shaped.

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