In the quest to achieve a client's investment objectives, advisers know selecting the right mix of assets is paramount. AssureInvest Director Andrew Doherty provides a deep dive into his firm’s investment philosophy, strategy and best practice principles, shedding light on the crucial factors that determine success.

The role of financial advisers in managing other people’s money – including picking stocks – has been long debated in the advice landscape.

This reflects two different schools of thought: some argue the role of a financial adviser is to focus on providing strategic advice and leave stock selection to dedicated investment professionals. Others believe that choosing investments and managing portfolios is a fundamental part of being an adviser.

Whichever school of thought you subscribe to, grasping the fundamentals of portfolio construction is essential to ensure clients get an investment solution that aligns with their needs and objectives.

Insights into stock selection from a boutique investment firm

When building a diversified portfolio there are two key considerations for advisers: asset allocation and fund manager or stock selection.

This article focuses on stock selection, exploring how AssureInvest, a boutique investment firm, successfully manages its concentrated Australian equity portfolios for its accounting and financial advisory clients. It examines AssureInvest’s investment philosophy, strategy and risk management framework, giving you an insight into how to develop, refine and benchmark your portfolio construction methodology.

What’s your investment objective?

Setting clear investment objectives is paramount before diving into stock selection. AssureInvest’s objective is to consistently outperform the S&P/ASX 200 Accumulation Index over the long term when it comes to Australian shares. For multi-asset portfolios, the objective is to grow wealth while keeping an acute focus on individual risk tolerance and asset class preferences. To achieve these goals, AssureInvest employs a fundamental, bottom-up approach to stock selection, looking for companies with outstanding prospects that offer attractive value.

Identifying outstanding businesses that represent attractive value

According to AssureInvest, outstanding businesses have a sustainable competitive advantage, growth potential, reliable cashflow, strong free cashflow, a solid balance sheet and a focused, experienced management team. To expand this a little:

• Outstanding businesses typically reinvest capital at high rates of return to become compounding machines. They can create extraordinary value for shareholders over time,
• Attractive value companies display strong earnings multiples, price-to-book ratios, price-to-cashflow ratios, free cashflow yield and dividend yield.

AssureInvest assesses business fundamentals and market information to narrow the S&P/ ASX 200 universe down to a short-list of 40 or so companies, before conducting extensive proprietary research to identify to best 12-20 stocks based on the group’s criteria.

Stocks are assessed on a range of factors and assigned an A, B or C rating, with their inclusion and weighting determined by their level of attractiveness, adherence to broad investment guidelines and parameters.

Best practice principles

To ensure a robust and disciplined approach to portfolio management, every advice business should establish a clear investment strategy and risk management framework.

These guidelines provide the basic rules that dictate portfolio composition, including the minimum and maximum number of stocks in a portfolio, stock and sector limits, and maximum cash holdings. Such principles not only guide decision-making but also allow advisers to effectively communicate with clients how portfolios are constructed and managed, and ultimately, how they are expected to perform.

AssureInvest’s best practice principles include:

• Transaction size: each transaction should be at least 3% of the portfolio
• Trade frequency: while transactions can occur on any given day, they usually take place less than once per quarter
• Maximum stock weight: no single stock should exceed 20% of the portfolio’s total value
• Position active weight: The portfolio may have relatively large active weights, which can result from a concentrated investment style and preference for high quality assets
• Sector active weight: sector weights should rarely exceed 15% of the benchmark to achieve reasonable diversification across industries
• Business quality: AssureInvest has a strong preference for companies with a sustainable competitive advantage and low business risk
• Portfolio turnover: typically, the portfolio’s turnover rate should remain below 30% per year
• Cash weight: The maximum cash allocation is 20%. A neutral position is usually around 5%. Anything above or below 5% is determined by the attractiveness of available investment opportunities

How much cash?

In addition to stock selection, the allocation of cash within a portfolio holds significant importance. Cash serves various roles, including providing liquidity, flexibility and diversification.

An allocation to cash enables investors to take advantage of investment opportunities as they arise, which is particularly important in uncertain conditions when volatility can create opportunities to capitalise on market dips.

On the flip side, too much cash can be costly, especially in robust market conditions, as it may adversely impact returns.

"Portfolios can be implemented a number of ways including via a trading and execution platform like Desktop Broker."

What is the outlook from here?

There are still pockets of value for patient, long-term investors, despite the likelihood of squeezed corporate margins due to lower revenue growth, rising living costs, stagnant wage growth, and higher interest rates affecting discretionary consumer spending.

Advisers should focus on businesses that can pass on higher costs to customers, usually driven by their sustainable competitive advantage within their respective markets. The ability to offset rising costs becomes particularly attractive in inflationary environments.

Advisers should also seek out companies with characteristics such as loyal customer bases, expanding distribution networks, and those well-positioned to benefit from Australia’s growing and aging population.

By adhering to best practices and considering these investment themes, advisors can optimize their portfolio construction methodology and provide their clients with a strategy designed for long-term success.

Desktop Broker is an Australian-owned trading platform for advisors that's been around for 15 years and is part of the Bell Financial Group. That's solid ground for your business to grow.

This information is general in nature only and you should consider whether it is appropriate for you.  For more information visit desktopbroker.com.au or call 1300 786 199. Desktop Broker is the trading name of Third Party Platform Pty Ltd ABN 74 121 227 905, AFSL 314341.