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How a sensible, systematic and transparent approach to investing can complement a holistic financial plan

  • By Jason Stockwell

David Jones and Nathan Lacaze use their personal experience to highlight both the art and science of financial planning – and investment management in particular


The adviser’s viewpoint, by David Jones, Vice President and Head of UK Financial Adviser Services at Dimensional Fund Advisors

At the start of my career as an IFA in the early 1990s, like many of my peers, my approach to identifying funds to recommend to my clients was to focus on recent past performance. Armed with my copy of Money Management magazine, a ruler, and a highlighter pen, I would identify a shortlist of star performers on whom I would undertake appropriate due diligence to pinpoint those I believed would perform well in the future.

When they did well, I attributed the good performance to my and the managers’ skill. When they did not, I found myself apologising to disappointed clients for things not working out as expected.

By the 2000s, I had adopted a more holistic approach to financial planning. Alongside investment expertise, I offered my clients comprehensive financial planning including full cashflow modelling. Having created a client’s plan, I also understood how important it was for them to stick to it. I realised that, to help my clients maintain discipline, I must seek an investment approach that could add value, was understandable, and seemed repeatable.

This led me to the discovery of a comprehensive body of academic research into capital markets and a sensible and systematic approach to investment management. It was the perfect complement to my thorough financial plan; a world away from the ruler and the highlighter; and my clients found that understanding why their investments performed as they did helped them to ride out market movements.

The portfolio manager’s viewpoint, by Nathan Lacaze, Co-CEO and Head of EMEA Portfolio Management at Dimensional Fund Advisors

Dimensional was founded in 1981 with the goal of delivering value-added systematic investment strategies to investors. We have been working with financial advisers to help meet the needs of their clients for more than 25 years. Our expertise is in using information in market prices to design and manage sound investment solutions. We look to do so in a manner that is sensible, systematic and transparent. These words are used frequently in our industry so here is what they mean to Dimensional:

Sensible

In its most basic form, investing is all about tradeoffs. For example, when you invest in stocks you expect to earn a premium over the risk-free rate, but know that there is a chance of losing capital: the trade-off is that you take on risk in anticipation of a higher reward. We recognise that we cannot eliminate this uncertainty – but we can sensibly account for it in the way we design portfolios and try to ensure we do not add to it unnecessarily.

The chance that all stocks have the exact same expected return is virtually zero. There is a multitude of reasons why different stocks should have different expected returns. Among those reasons are differences in risk, or differences in the tastes and preferences of investors.

So how can you identify these differences? Valuation theory provides a framework around the drivers of expected stock returns. It suggests that the price of a firm’s stock should depend on a few variables, including what the firm owns minus what it owes; its expected profits; and the market discount rate applied to those expected profits (or, equivalently, the expected return on the stock).

Hence, holding all else fixed, companies with lower market capitalisations and lower relative prices should have higher expected returns. Similarly, all else fixed, companies with higher profitability should have higher expected returns.

So valuation theory provides a sensible framework for the size, value and profitability premiums that we pursue in equities, and a similarly sensible framework exists around the drivers of expected fixed income returns.

Empirical evidence is also important in that it can inform robust ways to pursue these premiums, how large we might expect them to be, and help affirm that what we see in the historical data is not just there by chance. This gives us confidence that the premiums that we pursue are likely to persist in the future.

The noisiness of returns, a media that feeds worry and fear, and the inherent uncertainty that comes with investing all make being a long-term investor difficult

Systematic

Starting with a sensible framework is critical but, because prices and therefore expected returns change every day, so is a systematic focus on consistent and effective management, day in and day out.

Our portfolio management team is always looking to position our portfolios to beat benchmarks. But we are careful not to design concentrated portfolios with unnecessary turnover that might impose needless risks and costs on investors.

Additionally, our eligible universe also consists of more than 14,000 stocks across 40 or so countries. To be able to account for the complexity involved with this requires a process that intelligently balances higher expected returns, diversification, and costs.

Finally, we recognise that most investors have long investment horizons; an investor saving for retirement may accumulate assets for 30 years, followed by 30 to 40 years of spending. We believe a team-based approach with low reliance on any one individual provides a great foundation for investors to build a multi-decade investment plan because it provides for continuity of the investment process, allowing efficient enhancements through time since innovations in one area of the team can be adopted broadly.

Transparent

Beyond attempting to add value in a way that is systematic, we want our clients to be able to understand what to expect from our strategies. The noisiness of returns, a media that feeds worry and fear, and the inherent uncertainty that comes with investing all make being a long-term investor difficult.

As David knows from personal experience during his early days as an adviser, without having a way to see what is driving a manager’s returns, it is challenging to manage expectations with clients. We want to make it easy to confirm that we are doing what we said we would.

What do we hope the outcome of these qualities is? In a word, reliability. We understand that investing is about more than numbers. The relationship between an asset manager and a financial adviser, like the relationship between a financial adviser and their client, is built on trust. We believe a more consistent investment process can provide advisers and their clients the freedom to direct more focus toward the other aspects of a comprehensive financial plan and the confidence to stick with it over the long haul. This adds up to a more successful investment experience.


About David Jones

David Jones is Vice President and Head of Financial Adviser Services at Dimensional Fund Advisors Ltd. in the UK and Europe.

He works with financial advisers to help them build their usinesses on the solid foundation of a robust investment philosophy. Prior to joining Dimensional, David was the managing director of his own financial advisory firm, where he provided pensions and investment services to corporate and private clients.

David holds an MA in military studies and a BA in American studies from the University of Manchester.


About Nathan Lacaze

Nathan Lacaze is Co-CEO of Dimensional Fund Advisors Ltd. (DFAL). In addition to his Co-CEO responsibilities, he is Head of EMEA Portfolio Management, a Director of DFAL, a member of DFAL’s investment and management committees and on the Board of Directors of Dimensional Funds PLC and Dimensional Funds II PLC (Irish UCITS managed by DFAL). In his role as Head of EMEA Portfolio Management, Nathan oversees the management of existing portfolios and helps design and implement new strategies. He also takes an active role with clients.

Nathan joined Dimensional as a trading assistant in 2004 and received a bachelor of chemical engineering and a bachelor of commerce, with majors in finance and economics, from the University of Sydney. He received an MBA from the University of Chicago Booth School of Business and is a CFA® charter holder.

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