The compass to guide your investment journey

^{By: Martiens Barnard, Marketing Actuary at Momentum Investments}

Investing is personal and success for clients is about achieving their personal financial goals. To achieve this, clients need to make sure their investments are aiming towards the same goal or outcome as they are. This is a key objective of our investment philosophy called outcome-based investing.

To illustrate this, let’s look at an example. We’ll consider three funds, each with a different benchmark which they are trying to outperform.

Example

A client is trying to build up an investment over the next seven years to purchase an asset worth R100 000 today. He has R1 000 to invest monthly (increasing with inflation) and is considering the below funds:

He needs to consider that seven years into the future, the asset will cost close to R140 000 assuming inflation of 5%.

A simple projection over seven years and investment returns of CPI + 6%, leads to an investment value of just more than R140 000.

Fund M, that aims to outperform CPI by 6%, is a perfect match for the client’s objective. There is also another consideration that makes this fund an appropriate choice.

Should future inflation turn out to be less than 5%, the asset will cost less but the fund’s performance benchmark (CPI + 6%) would also be lower (as CPI is lower). Should future inflation turn out to be more than 5%, the asset will cost more but the fund’s performance benchmark would also be higher. Therefore, the benchmark that the fund is trying to outperform matches the client’s objective.

When performing at their respective benchmarks, Fund P is reliant on similar funds (in many instances their peers) outperforming inflation by 6% and Fund E on the equity index doing so. Their benchmarks, therefore, aren’t closely aligned to the client’s objective.

But outcome-based investing is not just about using an inflation-linked benchmark. It is about making investing personal. For Momentum Investments, it is about being very intentional about how much risk should be built into a portfolio. It is about communicating this risk to clients so that they can better understand if they will be able to withstand the ups and downs of their investment journey to lower any potential behaviour tax. Outcome-based investing is also about designing portfolios that we expect will outperform the benchmark with the highest probability and not just on average.

How do we do this?

Firstly, we consider the client objective. To understand the needs of a client, we follow a three-step process. This is done before the construction of any outcome-based investment funds or model portfolios.

We start with the time frame in which a client wants to achieve a goal.

We then set a risk budget, which informs us how much risk we can build into the portfolio. In short, this means we calibrate the investment’s asset allocation so that negative returns over the short term would realistically not exceed the level of risk the client has in mind. This is crucial to help clients stay committed to their investment goals.

We then provide the return objective, that is by how much we believe the fund will outperform inflation when measured over the stated time frame.

It is only then that we start to construct the actual outcome-based investment.

Our portfolio construction process is built and managed around three pillars i.e. strategic asset allocation, style optimisation and mandate selection.

Investing is personal and success for clients is about achieving their personal financial goals. Outcome-based investing moves beyond trying to outperform peers and indices, to increasing the probability of achieving client goals.

So, the next time you make an investment, ask yourself if the compass that guides your investment decision is built with achieving your clients’ personal goals in mind.

The information in this editorial is for general information purposes and not intended to be an invitation to invest, professional advice or financial services under the Financial Advisory and Intermediary Services Act, 2002. Momentum Investments does not make any express or implied warranty about the accuracy of the information herein. Momentum Investments is part of Momentum Metropolitan Life Limited, an authorised financial services and registered credit provider (FSP 6406).