How to take a simple, flexible and human approach to portfolio construction
Behavioural economics has taught us that people are imperfect.
They find losses more painful than gains (loss aversion). They pay too much for an immediate benefit rather than a later payoff (hyperbolic discounting). They mistakenly think future probabilities – such as a potential second year of negative returns – are less likely because of past events (the Gambler's fallacy).
These, and many other behavioural biases, encourage poor decision making, particularly when markets are under pressure. Financial advisers see these human flaws every day. They know the minds of investors better than anyone. But when it comes to changing human behaviour, there's only so much anyone can do.
This is why the best portfolios should be built on the core principles that drive investor behaviour.
Milliman’s range of SmartShield managed accounts combine protection, diversification and affordability, helping advisers build portfolios that work with their clients’ innate tendencies, rather than against them.
Affordability
Investors have been primed to look closely at the level of investment fees thanks to a sharp focus by regulators, media, and even industry fund advertising. Many advisers also look closely at fees when recommending a product in order to meet their best interests duty.
Higher fees rarely equate to better value. The Productivity Commission found that two out of three MySuper products which charged the highest fees (above 1.5%) were also ranked among the worst underperforming default products between 2008 and 20181.
High fees may become an even bigger issue in future. When markets deliver low or even negative returns, investment fees quickly become a more noticeable drag on performance.
At the other end of the scale, Milliman's SmartShield managed accounts charge total portfolio fees of no more than 0.50 percentage points, giving advisers a cost-effective way to customise clients' overall investment strategy.
Diversification
Diversification is an important tool in an adviser's portfolio construction toolkit to manage risk-adjusted returns. SmartShield offers well diversified portfolios that invest in easily understood asset classes including equities, fixed income, property, and cash.
Milliman monitors and regularly rebalances these asset allocations as market conditions change.
SmartShield funds can also play multiple roles in a client’s broader portfolio. They can form its core while satellite investments tilt the portfolio towards specific growth opportunities or values aligned with an adviser or client views.
While portfolio diversification is a powerful investment tool, it also has its limits, particularly during a systemic market downturn where all asset classes tend to fall in value. In these cases, specific risk management tools can help manage the impact of a bear market.
Protection
Risk management plays a crucial role in keeping investors level-headed during times of stress and on the path to achieving their financial goals.
SmartShield comes with in-built risk management protection against volatility and extended market downturns, which advisers can switch on or off without incurring capital gains tax.
This is achieved by using exchange-traded futures contracts – the protection is dynamically implemented in response to changing market conditions. It allows for more potential growth during strong markets but applies more protection when markets are rough.
The robust risk protection strategy at SmartShield’s core allows advisers to concentrate on delivering tailored client service and growth opportunities, safe in the knowledge that they are delivering a reliable investment approach.
You can find more information about the Milliman SmartShield range at https://advice.milliman.com/en/smartshield.
Disclaimers
This document has been prepared by Milliman Pty Ltd ABN 51 093 828 418 AFSL 340679 (Milliman AU) for provision to Australian financial services (AFS) licensees and their representatives, and for other persons who are wholesale clients under section 761G of the Corporations Act.
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All investment involves risks. Any discussion of risks contained in this document with respect to any type of product or service should not be considered to be a disclosure of all risks or a complete discussion of the risks involved. Investing in foreign securities is subject to greater risks including: currency fluctuation, economic conditions, and different governmental and accounting standards. There are also risks associated with futures contracts. Futures contract positions may not provide an effective hedge because changes in futures contract prices may not track those of the securities they are intended to hedge. Futures create leverage, which can magnify the potential for gain or loss and, therefore, amplify the effects of market, which can significantly impact performance. There are also risks associated with investing in fixed income securities, including interest rate risk, and credit risk.
An investment in an underlying portfolio, whether with or without Milliman Managed Risk Strategy (MMRS) is subject to market and other risks and no guarantee or assurance is given by Milliman AU or any company in the Milliman group that the use of MMRS in connection with an underlying portfolio will not give rise to losses or that the performance of the MMRS in relation to the underlying portfolio will remove volatility completely or to the extent depicted in an illustration or fully replace losses in the underlying portfolio or to the extent depicted. While generally assets used in connection with the MMRS are liquid, this may not be the case in all circumstances. Further, during periods of sustained market growth, the return to clients from the combination of an underlying portfolio and MMRS should be less than if a client had no MMRS.
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Past performance information provided in this document is not indicative of future results and the illustrations are not intended to project or predict future investment returns.
Any index performance information is for illustrative purposes only, does not represent the performance of any actual investment or portfolio. It is not possible to invest directly in an index.
Any hypothetical, backtested data illustrated herein is for illustrative purposes only, and is not representative of any investment or product. RESULTS BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD, THESE RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. For any hypothetical simulations illustrated, Milliman AU does not manage, control or influence the investment decisions in the underlying portfolio. The underlying portfolio in hypothetical simulations use historically reported returns of widely known indices. In certain cases where live index history is unavailable, the index methodology provided by the index may be used to extend return history. To the extent the index providers have included fees and expenses in their returns, this information will be reflected in the hypothetical performance.
1Productivity Commission Inquiry Report: Superannuation: Assessing Efficiency and Competitiveness, December 2018. p179. Retrieved from https://www.pc.gov.au/inquiries/completed/superannuation/assessment/report.