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Footballing lessons on building a balanced portfolio

Sad to say, but another European Championship has ended in disappointment for England fans. With just six weeks to prepare, Roy Hodgson’s focus on defensive play took them further than many expected. In the end, however, functional football just wasn’t enough.

As Spain and Germany regularly demonstrate, success in football requires finding a balance between attack and defense, and having the flexibility to adapt. While focusing on one discipline has a chance of producing success in the short term, it leaves you at the mercy of more balanced teams, better able to respond to changing conditions.

In many ways, constructing a robust investment portfolio is not unlike building a winning football team. With the European Championship behind us for England fans, a little analysis provides some valuable lessons for the art of portfolio construction.

Finding the right balance

 

The first of these is the importance of balance. Just as the England team demonstrated the limits of pure defence, so too a portfolio composed entirely of government bonds and cash is unlikely to deliver the long-term growth many investors look for.

At the other extreme, investing only in high-risk equities could leave your portfolio exposed to the whims of the economic cycle. In the same way that no manager would seriously consider fielding eleven strikers, it would be a brave investor who put their nest egg in only volatile assets.

If your investment portfolio is going to be robust, due consideration needs to be paid to the mix of asset classes. There should be a balance between investments held for their potential to generate growth, and others owned in the expectation that they will smooth the pattern of returns.

As with football, there’s also an advantage to diversification, to reduce risk. Just as a good manager can rotate to mitigate the chance of injury, holding a range of assets which behave differently in different conditions can reduce the risk of relegation at the end of the season.

The right formation for your portfolio will depend on your clients’ needs, but is likely to contain equities, bonds and cash – the classic formation of the investment world.

Playing total football

So far we’ve talked about the importance of finding the right balance in a portfolio of investments or players, and making sure there’s a suitable level of diversification.

The trouble is that conditions change – and as they change the balance shifts too. When markets are uncertain, there’s an advantage in fixed income and cash investments. As we all know, in a bull market (remember those?) there is an advantage in owning more equities.

The best football teams are able to adjust their formation and tactics to suit the environment on the pitch. This was exemplified by total football, pioneered by the Dutch, which required players to adjust to an attacking, midfield or defensive role as required.

A similar approach is behind an investment approach that has gained popularity in recent years: active asset allocation. Here, the manager of an investment portfolio will constantly review the portfolio in the light of changing market conditions, with a view to capturing opportunities as they arise, and mitigating exposure to assets likely to decrease in value.

Done correctly, this has the potential to smooth out investment returns, and even to enhance them over time. If it goes wrong, it can be a fast route to a round one knock-out.

Scouting for talent

One of the first lessons football managers learn is not to rely on the past performance of players. Other factors need to be taken into consideration too, such as fitness levels, commitment and the ability to work well with the rest of the team.

In exactly the same way, the past performance of individual securities needs to be viewed with caution when constructing a portfolio. Companies, economies and market environments all change, and what worked three years ago is likely to have limited relevance today. See the contrast between Germany’s flexible 4-2-3-1 formation and England’s rigid 4-4-2 for the latest evidence in the football world.

This brings me to my final point here, which is research. Just as talent scouts look at a range of metrics when searching out tomorrow’s football stars, investors really need to “kick the tyres” when reviewing holdings or potential additions to the portfolio to have similar success.

It might be another four years before the next European Championship, but perhaps with a little application we might see the results in both football and investment portfolio performance next time round.

Ian Pascal is head of marketing and communications at Baring Asset Management

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