Portfolio Construction The Key to Smart Investing 2007_04_19.pdf (PDF - 51KB)

Sydney, 19 April 2007 - In an environment continually seeking above market returns, Nelson Wicas, principal of Vanguard's Asset Allocation in the United States is encouraging Australian investors and advisers to unlock the secrets of investing by learning from large institutional investors around the world.

Advisers and individual investors alike can use the same principles in constructing investment portfolios that professional institutional investors use by adopting a "core and satellite" approach to investing. While the typical allocation for global investors in the US is approximately 60 per cent allocation to core type assets such as index funds and 40 per cent to satellite such as active funds, Mr Wicas says there is huge opportunity in the Australian market to try to keep costs and taxes low, while at the same time trying to identify active managers that can add value.

Mr Wicas said, "Investors often ask me whether indexing is preferred over active management. Although history is not an indication of future performance it has shown that indexing outperforms about two thirds of active management; therefore the key is to use indexing as a central building block of a portfolio, and then try to find quality active managers to add alpha or outperformance."

However, identifying those active managers is not easy. Mr Wicas says, "Like Europe, the Australian marketplace is dominated by some big players in resources and banks with many smaller stocks making up the rest of the market. At the large cap end of the market, the returns are influenced by systematic risk factors, with the probability of outperforming being very low. "

The chance of being able to forecast these systematic risks including major political and economic reforms is very small. Likewise, trying to identifying the next investment fad is very difficult."

A study (see below) over the last 100 years which looked at the sector weightings in the UK and US market showed that railroads made up 50-60 per cent of both indexes in 1899, but were only 0.2 and 0.3 per cent of the indexes in the year 2000. "

The challenge for investors and active managers is trying to forecast whether an investment in a hot stock today will be a railroad stock of the future. The composition of the index can change dramatically over time, and being in a diversified portfolio will help investors capture the natural and economic changes that occur."