Q&A: Asset allocation with John Nunan

Introduction

John Nunan, until recently at Mosaic Portfolio Advisers, has become the third member of the Investment Committee overseeing Super Advisor’s model portfolios. Prior to Mosaic, John worked for Officium Group (which became Mosaic) and Macquarie Bank.

John will be sharing his insights and experience for the benefit of Super Advisor members and we’re very pleased to have him aboard.

To give you a sense of what makes John tick, we asked him three questions relating to risk profiles, asset allocation and appropriate portfolios.

Question: We tend to think it’s the ‘conservative’ investor who has the most trouble translating their risk profile into a portfolio. What’s your take on ‘conservative’?

John: A conservative investor is generally quite risk averse, but seeks some exposure to markets to make sure their savings aren’t left behind a growing economy. They shouldn’t hold all of their assets in a bank account but also shouldn’t be exposed to big losses in the event of a market downturn.

Ultimately it’s a question of risk. If you’re prepared to lose 10-15% of your capital in a GFC-type situation, but aren’t prepared to lose 25%, you probably fit the description of a conservative investor.

From a portfolio perspective, my experience has shown that many conservative investors are overexposed to Australian shares.

For instance, if you had a 40% allocation to Australian shares, you’d be exposing yourself to the risk of losing, say, half that allocation, or 20% of your overall portfolio (without counting losses on other assets). That’s too much. The Australian sharemarket fell by more than 50%, top-to-bottom, during the GFC. And such volatility comes with the territory in that asset class.

I think it’s more prudent for a conservative investor to divide that same 40% between Australian shares, international shares, property and infrastructure so that they’ll likely have offsetting factors (such as currency) to reduce overall losses in nasty scenarios.

Question: Sticking with our conservative investor, what returns should they be targeting?

John: Here’s an important point that I’d like to stress: your risk classification governs your portfolio construction, not your return. Risk appetite is an input in the portfolio construction process, your return is the output.

A more aggressive portfolio should be expected to deliver higher (and more volatile) returns over time, but for any given period the future returns are unknown. Your return in any period will be what the market provides.

Ask a long-term Japanese investor in ‘high growth’ asset classes like shares and property how they’ve fared over the past 25 years. It’s not a pretty story. The lesson is that such asset classes offer the opportunity for great returns but not the guarantee of them.

Another mistake I’ve seen investors make (either consciously or subconsciously) is selecting your risk profile based on the return you would like to earn. This way of tackling it typically leads to taking on more risk than desired and can lead to much larger losses than you are able to comfortably tolerate.

The way to look at your risk profile and construct your portfolio is to first assess the maximum loss you are prepared to endure.

Question: What if my risk profile won’t give me the returns I need?

John: Risk profile is inherent. It’s very easy to change risk profile (by taking on more risk) during the good times but much harder to stick with it when things get tough.

Adopting this approach is dangerous. For those saving for retirement, it’s better to set realistic goals, based on:

A. The value of the assets you’re starting with

B. Your ability to add to those assets

C. Time frame

D. The level of risk you are comfortable taking.

If the expected end result is less than you hoped for, it is better to either increase B (make sacrifices now to increase net savings) or increase C (work longer).

Those already in retirement should look to reduce spending or pick up some paid work, if that’s an option.

If you are a truly conservative investor, then investing aggressively could end badly. Remember that taking on too much risk is not only emotionally unpleasant, but it introduces the possibility that you end up with less than you would have by investing conservatively, due to the wider range of possible outcomes.

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Thanks John for sharing your insights with us. It's great to have you aboard.