Smart Portfolios
A practical guide to building and maintaining intelligent investment portfolios. By Robert Carver.
In theory building the right portfolio is straightforward. You just need to work out the mixture of assets that will give you the best return given the level of risk you can cope with, and what you expect to happen in the future. But it’s hard to predict the future – much harder than most people think. Making good investment decisions in the real world means grappling with that uncertainty, whilst trying to find the best trade offs between numerous complicated options with varying costs.
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Smart Portfolios will make those difficult decisions easier. It is an accessible guide to building and managing portfolios which deal with the trade-offs and uncertainties of the real world.
The author, Robert Carver, gained his expertise from managing multi billion dollar hedge fund portfolios. He has a firm grasp of the theoretical principles behind portfolio construction, which the book explains in a simple and intuitive way. Although theoretically sound and thoroughly researched this is no academic textbook. Instead Smart Portfolios gives you dozens of practical methods and techniques that you can use to create and maintain investment portfolios.
The world of investment is more diverse than ever, but also more complicated. Smart Portfolios will help you navigate that world.
Features
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Why diversification is the most important attribute in any portfolio, and the best way to achieve it.
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Explains why even investors that are terrified of risk must have exposure to equities, and also why 100% exposure to equities is never justified.
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How to blend assets with different levels of risk, and how to construct portfolios that suit the level of risk that the investor can cope with.
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Calculating the true annual costs of your investments, including costs that you may not even be aware of.
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Reducing your trading costs through smart rebalancing strategies to reduce the volume of trades you need to do, and smart execution tactics to reduce the costs of each of those trades.
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Properly accounting for future uncertainty and costs when making investment decisions.
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How to use systematic forecasting algorithms and discretionary forecasting when building and rebalancing your portfolio.
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How to create multi-asset portfolios for large and small investors in the UK and US.
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Covers portfolios containing active funds, passive funds such as ETFs, individual shares, or any combination of these.
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How to compare the costs of, and select the best ETF, in each asset class, region, country, and sector.
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What are the hidden pitfalls of inverse ETFs, leveraged ETFs, commodity ETFs, and currency hedged ETFs? Are Smart Beta or Robo Investing worth paying for?
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How to properly compare cheaper passive ETFs and more expensive actively managed funds.
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How many shares do you need to buy for adequate diversification? How should you select those shares?
Who should read Smart Portfolios
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The general principles in the book should be applicable to investors in most countries. The examples are drawn from the US and the UK because of the wide range of Exchange Traded Funds (ETFs) that are available in these countries, and because of my own personal experience. Nevertheless all the techniques I describe can be easily adapted for use elsewhere.
This book is primarily intended for professionals who are paid to manage other people’s money, from financial advisors, private bankers and wealth managers; right through to institutional funds. In addition, experienced private investors should find much of value in the approaches I describe here.
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The book is intended for experienced investors, as I don’t cover the detailed mechanics of how shares are purchased, or how ETFs and other kinds of funds work. Even experts in portfolio construction techniques should find this book worthwhile. I think we all need reminding that the models used in finance are based on assumptions that are usually wrong, and often dangerous.
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Finally, the methods in this book can be applied to any type of portfolio, containing one or more different kinds of asset. In particular, I show you how to invest in collective funds like ETFs, but also directly in individual equities. I also explain how and when it makes sense to combine these approaches.
From the preface
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This book is about answering three deceptively simple questions:
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What should you invest in?
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How much of your money should you put into each investment?
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Should you subsequently make changes to your investments through further buying or selling?
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All these questions involve trade-offs: the world of investment is a place without free lunches, and where you can’t eat all your cake and expect to have leftovers.
For example: should you invest in the portfolio with the highest return, the lowest risk, or some mixture of the two? Is buying a couple of investment funds sufficient, or is it worth creating a highly diversified portfolio, splitting your cash between dozens or even hundreds of funds and individual shares? Do you need to constantly buy and sell to make the highest returns, or should you save on brokerage costs and do nothing? Are the higher costs of actively managed funds justified by higher returns?
Making smart investment decisions also means worrying about uncertainty. Those who regard themselves as financial experts – such as journalists, economists and fund managers – continuously make highly confident predictions about what will happen in financial markets tomorrow, next week, or next year. But in reality the future is unclear and forecasting incredibly hard.
Life would be very easy if you knew with 100% certainty that bonds will definitely do better than stocks next year. But what should you do if there is only a 55% chance of bonds outperforming – and how do you calculate that probability?
My aim in this book is to provide an accessible and practical guide to creating and managing smart portfolios which can deal with the trade-offs and uncertainties of the real world. There are no fancy equations, and no prior knowledge of financial theory or statistics is required. Constructing and managing portfolios doesn’t have to be rocket science – you just need to be a bit smarter.
I will show you simple methods to create the portfolio that suits you best – regardless of how comfortable you are with risk, how much money you have to invest, what funds and equities you can buy, and how predictable future returns are.
The world of investment is more diverse than ever, but also more complicated. This book will help you navigate that world.
What's in the book
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This book is divided into four parts.
The first part covers the essential theory. You will understand the basics of why certain portfolios are better than others, what effect uncertainty has on the choice of the best portfolio, and how costs affect these decisions.
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Part two is about applying that theory to create portfolios using a top-down process. A top-down process involves starting with the big decisions before moving on to smaller ones. The biggest investment decision is to deciding which asset classes you want to own, such as bonds and equities, and how to divide your portfolio between them. Then you should look at how the equity part of your portfolio should be carved up, and the same for bonds.
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In the first two parts of the book I assume that future returns can’t be predicted and will be identical for all the assets in your portfolio. But in part three I discuss what you should do with your portfolio if you think you or others can predict future returns to some degree. I’ll explain some forecasting models I use to predict returns and demonstrate how totheir use them, plus as well as how to safely incorporate your own judgment into portfolio selection. I will show you how to you can evaluate actively managed mutual funds and unit trusts, and decide if they are worthy of inclusion in your investment shopping basket.
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In part four I look at what you should do after you’ve built your portfolio. Some trading is occasionally necessary to keep your portfolio on an even keel and to stop it becoming unbalanced. Part four explains how to do this rebalancing without it costing you a fortune in brokerage commissions and other costs. I also show you how to minimise your tax bill.
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Preface
Introduction
Prologue: What do we know
Part one – Theory of smart portfolios
Chapter one: What is the best portfolio?
Chapter two: Uncertainty and investments
Chapter three: Trying to find the best portfolio
Chapter four: Simple, Smart, and Safe Methods to find the best portfolio (without costs)
Chapter five: Smart Thinking about Costs
Chapter six: The Unknown Benefits and Known Costs of Diversification
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Part two – Creating Smart Portfolios
Chapter seven: A Top Down Approach to Building Smart Portfolios
Chapter eight: Asset Classes
Chapter nine: Alternatives
Chapter ten: Equities across Countries
Chapter eleven: Equities within Countries
Chapter twelve: Bonds
Chapter thirteen: Putting it all together
Part three – Predicting Returns
Chapter fourteen: Predicting returns and Selecting Assets
Chapter fifteen: Are Active Fund Manager Really Genuises? And is Smart Beta really Smart?
Part four – Smart Rebalancing
Chapter sixteen: The Theory of Rebalancing
Chapter seventeen: Portfolio Maintenance
Chapter eighteen: Portfolio Repair
Reference
Glossary
Appendix A: Resources
Appendix B: Cost and Return statistics
Appendix C: Technical stuff
Reference tables
Smart Portfolios(TM) is a registered trademark of Smart Portfolios LLC. The author and publisher have no endorsement from, or affiliation with, Smart Portfolios LLC.