Episode 8

May 10, 2023


008 - Asset Allocation and your Investments – what you need to know

Hosted by

Vincent Heys
008 - Asset Allocation and your Investments – what you need to know
Financial Wellness with Vincent Heys
008 - Asset Allocation and your Investments – what you need to know

May 10 2023 | 00:50:20


Show Notes

Getting your asset allocation right when you’re investing is the most important aspect for long term success. Find out more about asset classes, allocation and your risk profile with this insightful conversation between Adrian Saville, a portfolio manager and academic, and Vincent Heys, Wealthstack Founder.

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Episode Transcript

From wealthstack.ca Welcome to the financial wellness podcast series, where we discuss all kinds of financial principles, concepts, and products. Our aim is to make money matters. Simple again. Vincent Heys: Hey there, and welcome to my latest podcast. In this podcast, I'm unpacking the importance of the roast profile that you as a client complete, and how the asset manager interpret that into an asset location. And that asset location is probably the most important thing to decide on when you do an application for investment. Vincent Heys: I hope you enjoyed this fireside chat with me. In the studio today, I have Adrian Sabel from, um, all the way from South Africa. Adrian, it's great to have you. Uh, Adrian is a portfolio manager and also an academic. He's a guy that I've known for Adrian Jacques. Vincent Heys: It's nearly 20 years now already. It's [00:01:00] staggering to, yeah, it's quite a number. When I sometimes think about 10 years, it's normally 15 or 20 years, so can't believe it that we've known each other for about 20 years. Well, welcome to the show. Thanks Vincent. It's great to be with you. And, uh, I guess if it's 20 years, it means we've done, uh, we've done collectively a couple of crises, uh, and enough bull markets and bear markets across asset classes to, uh, have, uh, have a fair chunk of talking points. Vincent Heys: I'm sure we're gonna try to squat it in into, um, uh, 45 minutes a day. Um, Adrian, just before we start, don't you just wanna introduce yourself and give a little bit of background in terms of your. You know what you've done and what you're busy with at the moment. Sure. Um, well first that's great to be with you Vincent. Vincent Heys: Thanks for the invitation. Um, per your intro, I, uh, I've been involved in the investment industry since the late 1990s when I started an investment firm. Uh, it's through that, that we met each other, [00:02:00] um, and that investment firm started as an individual, uh, uh, wealth manager looking after. Um, uh, assets of, uh, individuals and families and, uh, then grew to an institutional manager. Vincent Heys: Um, uh, in 2017, that firm was sold and, uh, spent a couple of years, uh, with the, uh, with the new parent company. And then, uh, 2021. End of 2021, I joined, uh, genera Capital, which is a multi-family investment office. Uh, alongside my investment career, I've had the good fortune of, uh, being able to look after an academic career, and I have a professorship in economics, finance, and strategy. Vincent Heys: At the Gordon Institute of Business Science in Johannesburg, and, um, you say all the way from South Africa, but I have two things that are Canadian. I have a professorship at Rotman, uh, in Toronto, and I have, uh, a pr, a [00:03:00] permanent resident. Actually, I should, I should say I have, I have three things that are Canadian and I've got a wife that lives in Canada. Vincent Heys: So, you know, I spend as long, she doesn't listen to this. I'm safe. No, that's excellent. So, um, so I think that's the reason why I, you know, I, I love talking to you, Adrian, is, you know, both from that practical perspective, but also having a, a, um, that academic hat on when we talk about these things today. Vincent Heys: Mm-hmm. And so, um, so I think you, you're perfectly positioned in terms of helping our listeners understand the. The link between asset management on the one side when we talk about asset classes and strategic allocation that we love to talk about. But on the end client side, it's really about risk profile. Vincent Heys: So when they, um, when they sign up for an investment account per regulation, they need to complete a risk profile from the portfolio manager or the, the product provider. Mm-hmm. And that's the link between what the client sees on the one [00:04:00] side, the, the risk profile. But, um, from the asset management perspective, they translate that risk profile into an asset allocation and, um, portfolio management. Vincent Heys: And so, you know, uh, just for our listeners, that's the stuff that we wanna talk about, unpack for you. Um, and, um, I've asked Adrian to help me in this process. Adrian, as we jump into this thing, um, just quickly in terms of what is an asset class? So before we go there, Vincent, can I maybe just sort of add to your intro about the importance of. Vincent Heys: Uh, this asset allocation is, you know, very often asset allocation comes across as, you know, the dull end of the conversation where we risk profile you and you are called a moderate risk or an assertive or aggressive risk or conservative, you know, and that, uh, a couple of words as supposed to capture your investment appetite or your. Vincent Heys: Exposure to different asset classes. And we'll talk about the asset classes in [00:05:00] a moment, but if we gather up, um, the evidence from, uh, investment experience, I think that there are two. Absolutely fundamentally important things in driving investment results. If you can get two things right, they are this, give yourself as much time as possible. Vincent Heys: Time is one of the most powerful components, uh, of investment outcomes because time allows things to compound. It allows you to correct errors that allows you to double down on successful results. So, Compounding, uh, which is given to you by time, is this very, very powerful component. And then asset allocation is the different asset classes that you're exposed to over time. Vincent Heys: Um, and you know, in saying that it's self-evident that time is the one thing you can't control. You know, we've got, we've got what we've got left from our starting position. So time is outside of our hands. And that really emphasizes that you should get started as early as possible from, uh, in, in any [00:06:00] investment journey. Vincent Heys: The earlier the better. And, uh, once you've started that en journey or embarking on that journey, it's down to asset allocation. Um, those are the two most powerful components and. Asset allocation, which exposes you to different asset classes will then, uh, represent that, uh, investment appetite or your, your position on the spectrum of conservative through to aggressive. Vincent Heys: And different asset classes will give you, uh, those different exposures. So an asset class, um, is usually captured by, you know, a single clear descriptor, equities, bonds, cash, property, commodities. Each of those is an asset class and they have common characteristics, uh, which is why they belong to a class. Vincent Heys: And you can think of a class as being. A school or a collection. So, uh, in talking about an asset class, we think of things that have a lot [00:07:00] in common. And what they have in common is they're going to have similar structures and similar behaviors. So, uh, equities or stocks is an asset class, and equities represent ownership in a business. Vincent Heys: Uh, bonds are an asset class and they represent, um, money that's owed to you. So when you buy a bond, you're lending money. Uh, to another person, or cash is money in the bank and each of them is going to be influenced or driven by different economic factors, uh, different geographic factors, different political factors, different currency factors. Vincent Heys: And whilst those factors might be different, they tend to be common to the asset classes at the highest levels. So interest rates will have. A particular impact on property prices, economic growth will have a particular impact on equities and so on. So Adrian, uh, I mean obviously some of those more familiar, uh, asset classes that people would, would normally see in their mutual [00:08:00] funds, uh, or in their SEC portfolios, um, is something like equities and bonds, cash listed property. Vincent Heys: I mean, those are, those are the asset classes they would normally see in those mutual funds. What are the other asset classes that are less well known and would, um, that are normally in a client's portfolio, but they just maybe don't know about it? Um, and also maybe from a family office perspective that you involved in. Vincent Heys: What are those other, other asset classes that are, you know, um, not so familiar to the times? Sure. Okay. So there's, um, there's two things that you, that I'll add to your observation or two responses to your observation. The first is, Alongside those traditional asset classes that, you know, we've just listed. Vincent Heys: Um, equities, bonds, property, cash, those are the so-called traditional asset classes. Uh, you'll get other asset classes that are not as conventional. They still might find their [00:09:00] way into a portfolio, but they generally won't make up the bulk of a portfolio. And examples of that would be, Um, venture capital or private equity, uh, commodities where commodities might represent industrial commodities like copper. Vincent Heys: Um, uh, aluminum iron ore might represent agricultural commodities like, um, palm oil, um, or. Uh, pork bellies, uh, and, uh, uh, commodities might also represent precious metals, uh, like silver, uh, platinum and gold. So each of those would be, uh, an example, uh, of, uh, uh, different or perhaps, uh, another word would be alternative, uh, asset classes away from the. Vincent Heys: The traditional, and it's not that by being different or alternative, they are second choices. It's that they just tend to be, um, not the first place to go. When it comes to asset allocation, [00:10:00] usually the first place people go in asset allocation is to those so-called traditional of equities, bonds. Uh, property and cash. Vincent Heys: And then we should add the non-traditional or the alternative, which would be, uh, venture capital, private equity, commodities, precious metals. Um, and there's loads of others that we could add there. Um, uh, timber, uh, uh, you know, or, or land could be, uh, an example. The, uh, one of the characteristics that, uh, of that second set of the non-traditional is they, uh, very often tend to not be listed, which means they aren't easily tradable or available on public markets. Vincent Heys: And so, It's difficult for you and me in our individual capacity to go and buy them. We need to be taken there by a professional investment, uh, uh, office that would help us get access to the private equity or the venture capital. Um, [00:11:00] and then, sorry, I, I, I said two things, then we just, uh, drop the second one in very quickly. Vincent Heys: Then inside of each of those asset classes, there tend to be, there are generally subclasses. So for instance, in the case of equities, you might have developed market equities and emerging market equities, or you might have large cap equities and mid-cap equities. Inside of bonds, you could have nominal bonds or inflation linked bonds. Vincent Heys: So it quickly starts to become, In a more complicated or detailed, sophisticated as we start to dig into each of these asset classes. So Adrian, are you, um, would you agree that, um, the difference between a client with a smaller portfolio and a client with a bigger portfolio, um, is sometimes there's difference that the bigger the portfolio is, the more choice they have? Vincent Heys: Um, so, so as the portfolio increases, [00:12:00] you then have the ability to access, like, as you say, venture capital, um, private equity, some other stuff, which, which you can't normally find in a mutual fund. Um, and so there's maybe a different risk return profile for that type of client with, with more choice. Um, yeah, because that, that choice gives you optionality, it allows you to add different things into the basket, which wouldn't be accessible through smaller investment amounts. Vincent Heys: Now, you know how much, uh, is required to get you into those, uh, different opportunities is a function of a couple of things. It's a function of the market you're working in. So if you're working in, um, uh, a developed market, an advanced market where individual incomes and individual balance sheets are much bigger, Than emerging markets. Vincent Heys: You will probably find that you require larger amounts of capital, um, to get access to those, uh, other [00:13:00] opportunities. The, uh, the, the, the second, um, aspect. So, so first, you know, it's the, it's the. Market that you're working in. And second, it's the asset class that you're working in. Um, so you know, in the case of equities, uh, you tend to have far more optionality than in the case of perhaps venture capital or private equity. Vincent Heys: So, you know, this, this is, uh, I guess it depends answer, uh, to give you the economics answer. It very much depends on. The market you're in, but you're absolutely right. Larger amounts of capital generally give you more options and greater access. And so what we found in, um, especially in the, you know, Canada and, and other, um, I wanna say first world market, is that the whole, um, access to private property, uh, obviously is a, has been a big winner the last 20 years. Vincent Heys: And so when you look at, at, uh, private clients', uh, portfolios, there's a [00:14:00] big portion of their wealth that goes into, um, private property, which is one of those asset classes. But what, I guess what we often find is that, um, that's, uh, that's makes up a, a big portion of their total portfolio and obviously there's some risk to that. Vincent Heys: Um, in case of, of, you know, high interest rates and those valuations coming down for those clients. Just to, you know, add to that, if, um, uh, if you, if you take private property as. Uh, as a case in point, private property, I would describe as an asset class. Um, it has unique characteristics and different drivers to other asset classes, so, and one of the private property assets that we understand best is our home. Vincent Heys: And it tends to be the case that, uh, the bulk of our assets, Is usually allocated to our home. Um, and I've recently become a Canadian, uh, property owner, [00:15:00] uh, with my wife and based on Canadian property prices, uh, that this makes up now a very large part of my balance sheet. So you, so, uh, you know, that's a good way of thinking about an asset class is what's going to influence the price of your. Vincent Heys: Home, it's going to be the performance of the Canadian economy. It's going to be, uh, interest rates in Canada. It's going to be inflation rates. Uh, and then you might have specific drivers like what, uh, city are you living in? Uh, what, uh, province are you in? Uh, and then what suburb are you in? But broadly speaking, you would expect Canadian property prices to move sympathetically, that they generally move in the same direction. Vincent Heys: And that's what we would call asset class behavior. Adrian, just before we jump onto the, onto the next one, just, um, you know, let's just quickly compare equity listed equity versus private equity. Mm-hmm. Um, you know, we can also compare, let's say, bonds with private debt, for example. Uh, but let's just quickly [00:16:00] think about equities, uh, list equities and private and private equity. Vincent Heys: Um, you know, there's, there's components there in terms of how many equity holdings you have in the portfolio and how many private equity holdings you have in the portfolio. Uh, you talked about liquidity and, uh, illiquidity in the private equity. Might we just kind of jump into that quickly just to give the listeners a, a perspective in terms of if we talk about listed equity versus private equity, what, what the differences are. Vincent Heys: Sure. One of the, perhaps it's worth just, uh, giving some context to why private equity has become such a popular asset class as this has really been, you know, brought to the front by the likes of, uh, the, the Yale and Harvard endowments where. Uh, David Swenson was the, uh, the, the Chief Investment Officer at the Yale Fund and at the Yale Endowment, and produced a return, uh, in the order of 16% per year over 30 years. Vincent Heys: An [00:17:00] absolutely extraordinary number by any measure. And one of the big drivers of this return was, uh, private equity. So the distinction between public equity and private equity. Public equity is the stuff that we talk about. Every day. It's the things listed on the Toronto Stock Exchange, London Stock Exchange, New York Stock Exchange, um, Tesla, Microsoft, lvmh. Vincent Heys: Uh, these are, uh, you know, Alibaba, uh, Tencent. These are the companies listed on public exchanges. Uh, they are, uh, universally accessible. You and I can buy them. And, you know, we buy them, uh, in open transactions. They generally are relatively easy to buy, relatively easy to sell, and you can buy and sell them with fairly modest amounts of money. Vincent Heys: A couple of hundred dollars will allow you to buy a position in any one of these companies. Uh, that means that not only are they accessible, but they're also liquid. If we change our mind on. Microsoft this morning. Uh, we [00:18:00] can sell it this afternoon. That's the liquidity. We may not get the price that we want, but we can get out of the investment. Vincent Heys: Or if we like it, uh, this morning, we can have it in our portfolio by this afternoon. That's a public market. A private market is, um, argued to be attractive for a couple of reasons. The first is, uh, that it brings unique opportunities that are generally, that are generally not available, but they're available specifically to you or to a small set of people. Vincent Heys: And in this way, you can invest in a company that isn't publicly listed. But it is open to private investments, uh, and those private investments have the characteristic not only of being available to a smaller set of people, and so having a unique component that if just a small set of us can own it. Vincent Heys: Most can't. So that's a very powerful attribute in that in its uniqueness, uh, it has the capacity to behave differently than, than other things. [00:19:00] But the, the second aspect of private equity, as much as that uniqueness is a very powerful component. The second aspect is because it's private, it tends to require larger amounts of capital to get in, uh, usually hundreds of thousands or sometimes even millions of dollars, uh, for it to be made available. Vincent Heys: And the second aspect is not only is the hurdle higher, but the time horizon is much longer. If you want to get out of it this afternoon, you can't, uh, you are invested in it for a holding period of the, of, of, of the life of the. Of the private equity fund, which characteristically is five, seven, sometimes even more years. Vincent Heys: Let's not just say you can never get out of it. There is a secondary market. You can't always find a buyer, but that buyer will require time, paperwork, administration. So there's obviously, um, more risk involved in that private equity. Th tha thanks for bringing up the, the Yale endowments. So, so for the listeners, you know, they would be most [00:20:00] familiar with like a balance fund. Vincent Heys: Um, in some sort of format, you know, balance fund in a mutual fund or balance fund that they can, uh, choose to invest in through their, uh, defined contribution pension fund at home. At at work, for example, or the RSPs. Let us quickly, um, give us just a senti in terms of the differences between a normal traditional balance fund and a portfolio, which is more set up like the Yale Endowment, where we see a lot more smart money has moved to. Vincent Heys: You know, with this something in terms of changing that asset location, what are those two different ways of managing that same type of return outlook, but with different asset classes? If you, if you take the. Well, uh, let me start again. The, the, the famous, or perhaps now infamous, uh, balanced fund is what we would call a 60 40 portfolio or a 70 30 portfolio. Vincent Heys: And the 60, [00:21:00] 40, or 70 30 refers to your asset allocation. To equities and bonds, 70% equities, 30% bonds. The equities are supposed to be assertive or aggressive, and the bonds are supposed to be conservative and, uh, provide insurance or protection. So if you've got 70 30, it's slightly more aggressive, then a 60 40. Vincent Heys: Um, David Swenson's, uh, objection to this approach was that, um, you had your eggs, Uh, in two baskets, uh, which is better than having your eggs in one basket, but you've got your eggs in two baskets, equities and bonds. And he, he added another complaint and that was that. In his observation about the 70 30 portfolio, 60 40 portfolio is attended to be, he's making the observation in the US context tended to be very much a US dollar investment. Vincent Heys: So we're going to invest 70% equities, [00:22:00] 30% bonds, and it'll be US companies and US government bonds. And so David Swenson said there's, there are some very easy, almost self-evident things that you could do. That will help you to diversify away from this without giving up the return component. And so what diversification does more than gathering up extra returns, the first thing that it does is it manages risk. Vincent Heys: And in the language of investing then is you get a free lunch. Because if I can get the same returns with less risk, I've just got a free lunch. Um, and so Swen suggested that there were, you know, a handful of asset classes that you should allocate away from, uh, your 60 or 40, 70 30 portfolio. Uh, the first suggestion was you should take your US equities and allocate some of those US equities to, um, uh, to developed market equities, European equities, [00:23:00] Japanese equities, Australian equities. Vincent Heys: Uh, Canadian equities. The second, uh, would be that you allocate some of your us another pocket of your US equities to emerging market equities where you would get, uh, India, Brazil, um, Indonesia, the Philippines. So the equities could be put into other, uh, sub-components. He made a similar suggestion with bonds that the bonds that most 60, 40, 70 30 portfolios hold are so-called nominal US government bonds. Vincent Heys: Perhaps you should be allocating some of those bonds to inflation protected bonds, which has the same. Um, attribute of bonds and that they are government guaranteed, but they have a diff different element or a different driver that they are guaranteed to protect against inflation also. And so your nominal bonds would then be complemented or diversified away into nominal bonds. Vincent Heys: And then his further [00:24:00] suggestion was that you should put in these private asset classes like. Private equity where you could get, uh, a little bit of zip or zing in your portfolio because through the private equity you might be locked up for five years. Um, but. Uh, locked up in a good sense. Uh, but you would get this very powerful private equity return driver. Vincent Heys: Um, and in that way you would actually build a portfolio that was more diversified than your traditional portfolio and you hadn't given up. Any of your return components. And then he went on to deliver this, you know, with this incredible investment result. Um, if I've become animated at this point, um, it's because this is, you know, something we fundamentally, intrinsically believe in, uh, in, in, in, in our, my firm, generic capital. Vincent Heys: Um, uh, where, uh, this is exactly the way in which we construct portfolios with some slightly. Uh, some, [00:25:00] some additional diversifiers including, uh, precious metals and commodities, which David Swenson did not give as much, um, uh, uh, uh, recognition or emphasis to Adrian. So traditionally, also, the definition of risk in portfolio management language is normally volatility. Vincent Heys: Mm-hmm. You know, in terms of how the portfolio moves up and down through a period of time. Mm-hmm. Now there's also another way of defining risk, and that's the risk of losing capital. So, you know, which I, I normally kind of think is better because if I have volatility and the market goes up, I like that volatility because I want my portfolio to go the time that I don't like volatility is when it comes down. Vincent Heys: And so that is defining that, that risk in terms of the risk of losing money. Uh, and not just about up or down, because as you would know, when you speak to clients, very few of your clients will come back to you and say, oh, my [00:26:00] portfolio's too volatile. It went up too much. You know, they normally don't, people don't complain when the, when your portfolio go up too much. Vincent Heys: Uh, it's more when the portfolio goes down that, that, uh, that pin kicks in. In your kind of sense, um, what is your, what is your view on, on the definition of risk when it comes to portfolio management and, uh, how do you translate that over to clients? Sure. This is a massive topic and, uh, in the space of a podcast, uh, let me try and do justice to it. Vincent Heys: So the, I I I, I agree with you. The way that risk generally is spoken about is volatility and the volatility because people understand that things go up, things go down. The more they bump up and down the, you know, the argument would be, well, that's a much more volatile portfolio and therefore, It's, uh, it's riskier. Vincent Heys: Um, but as you've pointed out, upside volatility is lovely volatility. It's really downside volatility that, uh, people are [00:27:00] scared of or that causes, um, uh, uh, perverse behaviors that in downside volatility, that's when people sell or panic, um, uh, that doesn't dismiss. Upside Volatility. Upside volatility. Vincent Heys: People can often become greedy. Um, and can become too aggressive. So volatility, um, although it's presented as a proxy for risk, um, is I, I would argue is nothing more than bumpiness. And very often that bumpiness is, um, a, it, it, it creates bad behavior, um, uh, or perverse behavior. So, uh, you know, that's just to recognize that. Vincent Heys: That's one way of thinking about volatility. Another way of thinking about risk. So, sorry, let me, and let me just side pocket volatility for the moment and come back to your immediate question about risk. Um, [00:28:00] and, uh, uh, risk is, risk is the, is the, is the likelihood that you don't get to your outcome. Um, uh, that. Vincent Heys: You plan for years and years and years, and you invest and you imagine that you get to a destination and eventually, you know, as the moment arrives of, let's call it your retirement, that's the most obvious destination. Uh, you find that. You haven't done the necessary things and you, you, you, you don't have sufficient capital. Vincent Heys: Now, you could have managed all of your volatility on the way. I have a former colleague who says, you know, in your retirement you can't eat risk. Um, you know, you can only eat return. So, so, so there is a risk here that we cannot lose sight of, and that is the risk. That you, you arrive at a place other than what you imagined, and it's the wrong place. Vincent Heys: This is a very, very real risk. [00:29:00] On the way to that, there is an even greater danger. Uh, and you, you, you referenced it. That's permanent destruction of capital. And permanent destruction of capital is, uh, a circumstance where, uh, You put a hundred in and you land up with zero. Now, no amount of subsequent brilliance can compound zero. Vincent Heys: You know, a gazillion percent time zero is zero. Uh, uh, we've got all this way in an investment conversation. Uh, don't think we've said buffet, but you know, B Buffet says there's, um, uh, you know, there's two rules of investing. The first rule is don't lose money. And the second rulers never forget the first rule. Vincent Heys: Uh, you know, what he's talking about is the risk of permanent destruction of capital. Now volatility is bumpiness. And that means your 100 might become 90, but it's permanent destruction of capital. When that 90, when the, when the minus 10 is gone forever and you [00:30:00] can never recover it. Volatility is very different. Vincent Heys: It says I've got a hundred, it falls to 90, but the intrinsic value of the asset. Is such that it's worth 110, 120. And if I allow economic forces, industrial forces and time, uh, into the equation, I will realize that 120, 130 in the fullness of time. So intrinsic value is a very important part of this conversation and gives us a lens on risk. Vincent Heys: So, um, no thanks for that. So, um, so as we can see, I mean with portfolio management, it's, um, Those two drivers, you know, when we manage portfolios is the one, what is the return profile for the client and how do we deliver that return profile with the least amount of risk? And whatever the specific definition that the portfolio manage will attach to that, to that, um, to that risk. Vincent Heys: Um, Aaron, just before we move on, the link between, [00:31:00] um, the asset management and the risk profile, which I want to get you. Just quickly, if we just kind of circle back very quickly to the Yale endowment versus a traditional balance fund. Uh, you talked about that, that 60 40 or 70 30 split off a balance fund. Vincent Heys: Just for the listeners on the Yale Endowment, you know, I know that is moved quite a bit this last few years, but what is your, what do you think is kind of the root of sump that they. Do as the location now, um, to say, you know, this is how much I want to put in equities, private equity debt, private debt, and all these kind of things. Vincent Heys: What is, what is the rule of something from a listed unlisted growth versus income kind of asset classes? Well, you know what, what they did in that endowment is they stepped a long way away from the traditional approach, which as you've, uh, you know, noted is 60 or 70% into equities, they still kept that 60 or 70 inequities. Vincent Heys: But, um, they carved it up into sub-components. [00:32:00] And those sub-components were, you know, 15% in, uh, developed market equities, another 15% in emerging market equities, uh, another 15% in private equity or venture capital. Um, and then, you know, the, the rest or the starting position in your US equities. So although it still had that, You know, very large equity component. Vincent Heys: Uh, the division into sub-components gave it a very, very different, uh, uh, uh, risk profile. The, it's worth pausing here also for a moment just to. You know, acknowledge that or to, or, or, yeah. To acknowledge that, you know, Swenson said that in thinking about investment returns, there's really three, uh, core drivers, um, in your allocation. Vincent Heys: The first is your asset allocation. Uh, the second is your, Uh, is the, is the individual investments, your, your stock [00:33:00] selection that you allocate the asset to, and then your market timing. I go in and out of, uh, the investment and, you know, having made that observation, he then went on to, uh, make a very important further observation that, you know, of those three things, Asset allocation, stock selection, and market timing. Vincent Heys: Uh, the market timing and the stock selection are actually zero sum games that the only way you win is by someone else losing. And if it's a zero sum game, then for you to be doing. Market timing or stock selection, it essentially is an expression that, well, I am generally going to be right if it's a zero sum game, because for you to win someone else loses. Vincent Heys: So you, you're really backing yourself on stock selection and market timing. And having made the observation that not only are these zero sum games, uh, uh, uh, which puts you on on a fool's errand, you then, uh, have to add. [00:34:00] Costs into the equation, which makes the the loss for, for, for the aggregate a guarantee that. Vincent Heys: If collectively we must lose when we are doing market timing and stock selection. Uh, it cannot be a win-win outcome. And for that reason, uh, strengthen in the Yale endowment, Harvard Endowment really, you know, rewind all the way to asset allocation as being the fundamental principle, um, uh, the fundamental point of departure in portfolio construction and risk management. Vincent Heys: That that's perfect. So I do wanna encourage. Clients that when they invest into your portfolios to go and find that fact sheet or disclosure document and try to understand where the portfolio's invested in. Um, there's normally good indication in terms of, you know, whether it's a 70 30 portfolio or 60 40 or 90 10, whatever that is. Vincent Heys: But also try to understand how much of that portfolio is [00:35:00] and is an, uh, unlisted entities. Just to kind of give you a sense in terms of. Uh, where the risk will be, Edwin. So if we move, you know, um, we talked a lot about the back office of asset management now and, and to kind of give, um, um, the end client a little bit of a big, you know, view of, of what we talk about on the portfolio management level, the, the way that that world is linked to, um, a client purchasing a product. Vincent Heys: Is the link there is the risk profile. So what normally happens is, uh, you, um, give advice to a client or they want to purchase a, uh, investment product. And the first thing that the product provider would ask the client to do is to complete a risk profile. And the risk profile then links it back somehow to the right portfolio. Vincent Heys: Um, Would you maybe just give us a [00:36:00] sense in terms of what is that risk profile and uh, just how we link that to the portfolio? You know, what goes normally into that risk profile questionnaire, if I can say that. Um, and it's not uniform. I mean, different companies have different Sure. Questions Okay. That they asked. Vincent Heys: But what is, what is how, how, how do we bring those end client experience, uh, in line with the back office? So what, you know, what risk profiling is trying to do is it's trying to figure out, um, what your. Psychology is, uh, if you have got an appetite for volatility or the ability to tolerate volatility. Um, because one of the, I think one of the most difficult or even dangerous things that can happen, um, is, uh, a response or an observation along the lines of, well, this isn't what I signed up for. Vincent Heys: You know, you've put me into something that I didn't expect. Um, so we're trying [00:37:00] to work out that aspect of what is your. Uh, what's your mindset? What's your risk tolerance? Um, how you going to respond? You know, few, few people, um, are going to object to good times, you know, so they'll, they'll object to bad times how you're going to behave under those stressed circumstances or, or how you're going to respond under those stressed circumstances. Vincent Heys: That's one of the things that we're trying to work out. Um, we're also trying to work out your time horizon. Are you investing for a year? For three years? For 50 years? Uh, Yale Endowment has been around for 300 years. Uh, and you know, by their planning they're gonna be around for 300 more. Um, whereas you and I don't have that time horizon, um, and a person who's in their twenties has got a very different time horizon to a person who's in their fifties. Vincent Heys: So we're trying to work out time horizon. Um, we're also trying to work out, you [00:38:00] know, specific or idiosyncratic needs, uh, you might live in Canada, but regard yourself as a global citizen that the way that you measure your, well offness your wealth. Financial wealth is by a global benchmark, perhaps a US dollar. Vincent Heys: Um, uh, you might live in Australia and have an ambition to eventually retire in Brazil. So, you know, we shouldn't be measuring your returns then by Australian dollar. We should be thinking of them in terms of what they would buy in the Brazilian. Uh, so what's your currency of reference? Um, And then how many people are relying on this outcome? Vincent Heys: Uh, is it, uh, just, you know, the individual that you're speaking to? Is it the individual and a significant other? Uh, are there further dependent? Um, uh, do they have. Investment intentions beyond just looking after themselves. So do they have legacy assets, for [00:39:00] instance? Um, so there's a whole range of different things that we're trying to figure out, uh, in a conversation, um, uh, uh, with an individual about their risk appetite, um, so that we can figure out the currency, the time horizons, the appetite for volatility, their ability or willingness to put different asset classes into our portfolio and so on. Vincent Heys: So obviously that's, um, the, the feel for the endline is different speaking to a portfolio manager where they have a direct relationship with, because that portfolio manager can, as you just rightly said, can ask those detailed questions exactly about, um, you know, translating the risk profile into the correct portfolio when it comes to, um, I would, you know, just clients that are purchasing a investment product, they would normally just complete a risk profile questionnaire that's on paper or online, [00:40:00] and that company might issue like, let's say eight or 10 questions. Vincent Heys: So I, I do just think that, you know, clients should just, I, you know, take special reference and just make sure that they answer those questions. Uh, there's no wrong answer. It's just answer the questions the best you can in terms of. In terms of who you are and what your expectations are for this portfolio. Vincent Heys: Um, so that, um, uh, so that you just know that the product provider brings the right product to you based on your risk profile. That was just more of a comment. So, um, Adrian, let just talk quickly, you know, for those clients that aren't able to go to a portfolio manager like you, you know, where they complete those, those questionnaires online. Vincent Heys: On paper, the risk profile, um, for let's say a home deposit or education goal [00:41:00] should be different to the risk profile of a retirement goal. As you rightly said, you know, the, the time horizon for those two kind of things are different, um, and you don't have the time to make up a loss in a home deposit goal. Vincent Heys: Um, so, uh, compared to a retirement goal. So, um, so I do wanna just talk about that a little bit and also, um, get your feel on that, but also encourage the end line that when they complete those risk profiles, to have that specific goal in mind when they complete the risk profile for that goal. So, uh, that when you complete the risk profile for, let's say a home deposit, as we rightly said, think about that goal. Vincent Heys: Um, you're not supposed to think. About retirement in that sense, because otherwise you, they're gonna serve up the wrong account for you or wrong portfolio for you. Um, Adrian, yeah, maybe just talk into, into those types of, uh, risk profile asset locations. Let's talk the type of products that clients might [00:42:00] normally find with those different risk profiles or different goals should say. Vincent Heys: Sure. Uh, so Vincent, if you, you know, if I, if I've, if I've got money. You know, we talk here about, you know, mental accounting for financial pockets and mental accounting might be, um, I've got, you know, a hundred available for investment. But of that 120, uh, is for, um, a. University fund for my daughter and 80 is for my retirement. Vincent Heys: And if 20 is for the university fund for my daughter and she's going to university in two years time, then I can't afford to have that in a high volatility, uh, portfolio because, Although the high volatility should, and I really want to underline the word should, or the higher volatility should reward me with higher returns. Vincent Heys: You know, it could be that the moment I need those university fees. I'm in a [00:43:00] period of down volatility, um, and I then go to the portfolio and the cupboard is bare. So we need to be, you know, very careful about, you know, allocating money that is, you know, rainy day money or necessity money, uh, and putting it into pockets that are not well suited to the time horizon and to to, to caricature it. Vincent Heys: If, you know, if I was gonna live for a hundred years, Um, or retire in a hundred years time, then I can put it into private equity and venture capital. But if I'm going to retire in. Two years time, I probably shouldn't be in private equity and venture capital because the moment I go and try and pull some money out of that investment portfolio, they're gonna tell me it's not available. Vincent Heys: Um, or it's a very bad time for private equity and venture capital and they've just marked prices down so I can have my money, but it's down 20%. And so instead, you know, if it's to your retirement, you want to be. Arguably in a far more defensive, uh, position, [00:44:00] keeping in mind that, uh, life expectancies have changed dramatically. Vincent Heys: Um, and I mean, you didn't raise this point, but I'll drop it into the, uh, into the hat that. If we rewind to the 1970s, life expectancy was uh, mid sixties to late sixties. Life expectancy today is, um, early eighties to mid eighties, so advances in medicine, science technology means that people are living for a lot, lot longer, except their retirement ages are the same. Vincent Heys: Um, and I think that brings about an a completely different set of risks and needs for people looking after assets in retirement and planning for retirement. You, Adrian, thank you so much. You know what, um, I think there's another podcast coming, especially around life expectancy and defined benefit plans, especially in Canada, where so many people, um, uh, do have [00:45:00] defined benefit plans. Vincent Heys: Um, and, um, and the ones that don't have it, they are really, um, um, you know, they have that longevity liability on the balance sheet that they need to make sure that they can cover over the long term. Mm-hmm. Um, Adrian, thank you so much. Uh, you know, we can keep on talking about risk profile. Uh, we can keep on talking about as location. Vincent Heys: I, I hope this gives their listeners a good feel in terms of where that. Matches between back office and the portfolio that they wanna slate. Um, maybe just a last final thought from your site. You know, when, when we think about, um, the portfolio, when we think about risk, uh, risk profile, what is the one final thing that you would like to just, uh, maybe just speak to the listeners that are, uh, maybe not that, uh, investment savvy, that want to know more about investments? Vincent Heys: Um, because I often say to [00:46:00] clients, you know, no one will look after your money as well as you are. Uh, and so what is that one thing that you would leave with your, uh, with the audience? Um, you've asked me for one, I'm gonna give you two. The first is you, you made a comment earlier about when you fill out a risk, uh, a risk profile, um, uh, or risk questionnaire. Vincent Heys: Um, you know, there's no right answer. I think in a very often, uh, in the world of investing, people are. Intimidated people are, um, fearful. It's an industry that's filled with specialist language. Um, and for that reason, uh, oftentimes people sort of shy away from these conversations because they feel awkward or difficult. Vincent Heys: Um, this is a conversation you have to have. Um, and in having that conversation, I would agree with you. There's no right or wrong answer. There's [00:47:00] only. You know, here are the facts. So I'm going to tell you the facts about my risk profile because if I try and give you an answer that I think you want to hear, you're gonna build the wrong risk profile, and I'm gonna land up in the wrong place, which means we're now in the world of luck. Vincent Heys: Um, the second thing is that, uh, I, I've said it before, but I'll, I'd really like to underline it, is, The suggestion, uh, is that there's no such thing as a free lunch. You know, if we go to the, the, the textbooks, um, and I would challenge that in the world of investing there is such a thing as a free lunch, and that comes in the form of diversification. Vincent Heys: Diversification is about being in the right asset classes that are appropriate to your profile. It tends to be the. It's not the, talked about part of an investment portfolio. The talked about part of an investment portfolio is what have interest rates done, what has currency done or what has the stock market done or an individual stock, uh, done. Vincent Heys: Um, uh, you [00:48:00] know, what's your, Um, uh, what's your, um, mining company or bank stock done in the portfolio? What's the Tesla? Um, share price, done. These are interesting components, but they, I, I, I would argue that they, they're not the most important components. The single most important thing in your investment decision is getting asset allocation right to suit your. Vincent Heys: Horizon, your risk profile and your investment needs. This is the single thing, uh, that should be at the center of your focus, and it is the Freest Lunch available in investing. Adrian, thank you so much. Um, it was great talking to you. Thank you. Thank you always for your insight. Um, and to make things really simple for clients. Vincent Heys: I, I think there's a ton of things that they can, that they can dive into and kind of listen to. Just as a final thing, you know, um, Adrian also mentioned it about this men mental accounting and mental bucketing [00:49:00] of, of, of accounts into different places. Go and check out wst.ca if you haven't done so yet. Vincent Heys: Um, you know, we've specifically created that, that, uh, platform for people to, um, create goals for themselves, create those different investment accounts or different investment goals, and then link those specific accounts to those goals and to make sure that those accounts. Um, have the correct asset location that speaks directly into that ac into that goal so that you're not surprised, uh, with a different outcome in the future. Vincent Heys: Adrian, thank you so much. All the best. Thank you. And I'm looking forward, um, having you in Tara and having a good cup of coffee. Thanks for a great conversation and thanks to everyone for listening. Thank you. Bye-bye. . Vincent Heys: Hey, thank you so much for listening to our podcast today, you can find our content on wealthstack.ca or on LinkedIn. I'm Vincent [00:50:00] Heys and you've been listening to the financial wellness podcast series.

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