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Pick the perfect portfolio

With hedge funds prowling around to undermine the share price of even solid companies such as Fairfax Media and Qantas, the big question for investors has to be - how do I pick a perfect portfolio to benefit from this over-selling that must eventually reverse?

A few years back I wrote the Australian adaptation of The Complete Idiot’s Guide to Getting Rich by American financial guru Larry Waschka. Larry summed up the US view on risk profiles and expected returns.

“An aggressive investor should target investments with annual returns in excess of 15 per cent, moderate investors should shoot for 12-15 per cent and conservative investors 8-12 per cent,” he declared.

The conservative investor could be a little more cautious here but if we view these as real returns, that is minus the inflation rate, then they’re not bad ideals.

Certainly it is fair to say that simply choosing an index fund of the Aussie stock market could, if history can be the guide, bring a return around 12-13 per cent.

Three years ago I asked Rob Cornish, the property expert at Macquarie to do an objective comparison of property and shares. The results surprised me a little because property beat shares on a five-, 10- and 20-year basis but shares won through on a 15-year term.

But the big revelation was the confirmation that quality property or shares return around 11-13 per cent on average. So a perfect average portfolio should produce these kinds of returns in the long-term.

And an absolute perfect portfolio should improve on 11-13 per cent. Mind you, it borders on the greedy to try for these returns but as long as you know the added return goal adds to your risks, well that’s okay.

At the beginning of the market dive, my position on a ‘perfect portfolio of shares’ for the time was top 20 or top 30 stocks, which were big dividend payers. My view was quality companies were being unreasonably trashed.

A colleague who helped me do the research noted that Qantas was a great dividend but he was worried about oil prices, the CEO Geoff Dixon might soon retire, more competition on the Pacific route and US airlines companies were falling out of the sky into bankruptcy. (Pardon the pun for less-confident flyers.)

These judgement calls aren’t easy to make and so many investors avoid it and simply stick to their stated investment strategy. I’m in this camp.

Right now, with 8 per cent easy to get with bank fixed deposits, the perfect investment play was all your money in cash earning great interest until the market hit the bottom. When that happened and you timed it brilliantly you’d then buy blue chips and become rich safely.

However, it is all easier said than done. In fact, for long-term investors with the stock market valuations so low, it has to be a great time to create the perfect portfolio.

But how do you do it?
Waschka thinks normal people have a natural problem creating the perfect portfolio and therefore play it safe.

“I prefer to use managed funds,” he admitted. “They require relatively less attention and offer a level of diversification beyond any other investment opportunity in the world.

“From the standpoint of balancing risk with returns, nothing builds wealth better than managed funds.”

I don’t like to get too glowing about managed funds because they can over-charge. And given you can use a full service stockbroker for one per cent cost, or less if you want to do more work, there can be great long-term pay offs of not paying too much for investment help.

If you like the fund portfolio option, then the perfect fund should not charge you more than one per cent. Your problem is - do you go for a growth fund to ride up the eventual economic turnaround and market recovery? Or do you play with a value fund, which will identify companies with vastly and inappropriately reduced share prices.

And then again why not an index fund? They’re low cost and make good average returns and should reflect the 11-13 per cent return you might expect on a long-term basis.

Next for a balanced portfolio you need some foreign share exposure and some property. This means you have to research these funds, get some ratings and long-term track records and hope that the management team has not changed.

I know of a fund manager who got it right until the resources super cycle got under his guard and what used to be a great investment fund really is a bit of a dud now.

Creating a perfect portfolio is not easy. That’s why some people use an adviser, others buy an index fund while others punt on one good managed fund.

Ideally, if you can’t create your own portfolio of shares, funds and other assets, then a domestic, foreign and a property fund would be a decent start to perfection.

Published on: Friday, June 27, 2008

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