Well-Constructed Portfolio

well-constructed portfolio should deliver the characteristics promised to investors in a cost-efficient and risk-efficient way.

The well-constructed portfolio possesses:

  • a clear investment philosophy and a consistent investment process,
  • risk and structural characteristics as promised to investors,
  • a risk-efficient delivery methodology, and
  • reasonably low operating costs given the strategy.

Funds aiming to deliver different required characteristics will have different well-structured portfolios. The following general points can be made about portfolios that have the same desired characteristics:

  • Portfolios that can achieve desired risk exposures with fewer positions are likely to have more focus on risk management in the portfolio construction process.
  • If two portfolios have similar risk factor exposures, the product with the lower absolute volatility and lower active risk will likely be preferred (assuming similar costs).
  • If two portfolios have similar active and absolute risks, similar costs, similar manager alpha skills, then the portfolio with the highest Active Share is preferable because this will leverage the alpha skill of the manager and have higher expected return.
  • When selecting equity managers to create the equity allocation of a multi-asset fund, managers should be combined to create an overall equity allocation in the portfolio that is well-constructed. A risk factor exposure that is desired but not present in one manager could be compensated for by adding a different manager that specializes in generating exposure to that risk factor.

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