Principles of Investing for American Citizens Living in the UK: Principle 6 – Find an Investment Philosophy that works for you and stay the course

Written by Kyle McClellan & Ollie Cutting

“It’s not hard to make decisions once you know what your values are.”  ~ Roy E. Disney, co-Founder, The Walt Disney Company

We are all human beings with human emotions and impulses which can give in to fear and greed if left without a system of beliefs to shape the way we make everyday decisions. For this reason, investors can often be their worst enemy – selling when the markets are down, buying at the top, or choosing expensive investment offerings having been overly excited by the prospect of year-on-year market outperformance. Major studies tell us that the average equity and bond market investor has underperformed the general market over time (Source: DALBAR Quantitative Analysis of Investor Behaviour 2020).

It is well understood that risk and return are intrinsically linked over the long-term but without a core set of beliefs or guidelines within which to invest, it is easy to reduce your chances of reaping the rewards associated with the level of risk you take. At MASECO, we refer to our belief system as our Investment Philosophy, which defines why and how we recommend the strategies we do and how we can help our clients make rational, evidence-based decisions along their wealth accumulation journeys. Choosing the right philosophy to follow can be hard, but seeking out the following characteristics might be a good place to start:

1.)    Choose a Wealth Manager that has an Investment Philosophy!

a.    It is surprising how many Wealth Management practices do not have a documented set of core beliefs on which they rely. However perhaps representative of a changing tide away from ‘flavour of the month’ investment strategies towards evidence-based, quantitative approaches. If a Wealth Manager cannot clearly define the values that underpin their investment decisions, it could be a warning sign that their decisions are based on impulse instead of data.

2.)    Trust an evidence-based approach

a.    A wealth of data exists in the modern era, whether in the balance sheets of public companies or stock price movements recorded every second. This data is ammunition for academics and investment professionals, who are constantly seeking patterns and connections between business activities and the impact on stock prices over time.

b.    Whichever Investment Philosophy you decide to place your trust in, ensure that it is founded on a rational approach that can be evidenced by data. Of course, historical data is not an indicator of future performance, but understanding how security prices have moved over time can provide a useful guideline for the probability of generating future returns above a given benchmark.

3.)    Pay attention to costs

a.    The theory of finance and investing has evolved significantly in the 21st century, in tandem with technological progress and computing power. There are over 100 documented ‘factors’ of investing; perceived linkages between security price movements and underlying data, which could lead to outperformance above the general market by holding the right investments.

b.    The challenge still is putting theory into practice at an affordable cost.  If a strategy involves too much trading, or high fund fees as a result of paying for a team of star quantitative analysts, it may be that the potentially high gross returns become less attractive on a net basis after the total fees are taken into account.

c.    It is practical to seek out a strategy that tries to generate an additional return above the market by investing in factor-based strategies that are cost-effective to implement.

d.    From the hundreds of strategies written into academic theory, only a handful are practical and affordable in the real world. A good investment philosophy should carefully consider costs to drive a high risk-adjusted net-of-fees return.

e.    Tax-inefficiency is a cost, too – often we see strategies that are overly focused on gross returns, without considering the net return after fees and taxes. This is particularly sensitive for Americans living in the UK.

4.)    Diversify, diversify, diversify…

a.    It is becoming more widely understood by the average investor that diversification or spreading risk across many different types of security and asset class, is a healthy way to invest for a smoother investment journey.

b.    It is important, however, to look for a systematic approach for how and where to diversify your investment portfolio. At a high-level, you will want to understand how your investments would be split between Fixed Income (bonds), Equities (stocks), or Alternatives like real estate and commodities, for example. Beyond this, your Wealth Manager should be able to define how they over and underweight exposures geographically, by market segment, industry, or security type.

c.    It is easy to feel diversified if a manager has a long list of recommended positions or complex-sounding fund names in their allocation.  This does not always mean you are truly diversifying your portfolio risk. For example, a US S&P500 index fund may track the index of the 500 largest US stocks by market capitalisation, whereas a smarter option could be a US large cap fund that holds 1500+ positions and takes a more careful approach to the weighting of each company stock within its fund to avoid overweighting too heavily towards the largest companies, which can often be the most expensive.

d.    Avoid home country bias – in our years of investing for Americans living in the UK, and Britons living in the US, we have seen a clear trend in US-based managers having a natural overweight to the familiar – US stocks, and in the UK – UK stocks.  Taking a global approach, weighted broadly by market capitalisation, places less reliance on their home country having a ‘good year’ to generate strong performance.

e.    Always be cautious of an approach that claims to beat the markets by a significant margin. It could be that the cost of doing so is diversification – markets are cyclical and it is best to avoid greed and try to capture the performance of global markets, giving yourself a chance of outperformance, while ensuring a good level of downside protection. This is achieved by carefully thinking through diversification.

Please email masecocommunications@masecopw.com to receive a copy of our Principles of Investing whitepaper in advance.

The Legal Stuff

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