Building investment portfolios ‘like constructing a house’ – but with a catch

The process of constructing an investment portfolio is much “like building a house”, argues Datt Capital’s chief investment officer, Emanuel Datt. However, while it may require some added know-how, Datt argues that investors are in many cases better off leading portfolio construction.

As with any certified tradesman assigned to a construction job, Datt cautioned that certification of a fund manager only assures that the fund is built in a “systematic manner”, not that it performs well or is tailored for non-standard investment goals.

Fund managers, whom he compared to “tradesmen” in his analogy, often end up paying independent research houses for certification or ratings “to increase their credibility”.

This is done so that financial advisers – or the ‘builders’ – “can hire or recommend them to their clients”.

“This certification does not guarantee the quality of the job that will be performed (investor returns or investment performance)”, Datt reasoned, “but rather that the job will be performed in a systematic manner.”

Often, he said, builders – read, ‘financial advisers’ – will construct a house that fits within their own requirements rather than what the owner – or ‘investor’ – wants or needs. Namely, this is strong portfolio performance at an appropriate risk appetite.

“Builders (financial advisers) often can’t use tradesmen (fund managers) that do not pay research houses due to insurance requirements. Independent builders (advisers) may not have this requirement.”

Success in any portfolio construction, and particularly for those investors with more unique investment goals, therefore demands the “conscious participation” of its owners, Datt argued.

The foundations of a strong portfolio

“Investment portfolios are not built in a day,” the fund manager said.

“A portfolio is built over time by gradually acquiring and expanding investments, aided by flexible plan to suit investment goals over time.”

Building a strong portfolio – as with constructing any new home – requires adequate capital, which Datt compared to a “land holding”.

Taking the analogy further, Datt said that “an owner (which is the investor) has a number of options when it comes to building”.

For homebuilders on a budget, Datt said, there is the option of building their homes off-the-plan, via a ‘volume builder’, “where they can pick from a number of standard designs at a fixed price”.

These planned designs, he said, are effectively like ‘financial products’.

“These financial products may not be a perfect fit for the owner – [or] investor – and may be used to only fulfil short-term financial needs,” Datt said.

Datt posits two alternative options:

• to hire an independent builder – read, ‘independent financial adviser’ – to build a high-quality, unique home to the owner’s desired specification.
• for the owner of the prospective ‘home’ – the investor – to organise the building of the house – or portfolio – themselves.

For those wishing to hire an independent builder, there are drawbacks in terms of flexibility. Datt argues that while the complete house (or portfolio) may fulfil the needs of the owner (investor) over most timeframes, this option “may ‘lock’ the owner into decisions before the house is tangible”.

Taking the latter and likely most difficult route, involves owners taking initiative – at least in the early phase of construction – in hiring and working with various tradesmen (or fund managers) to construct the home.

“This option may provide the most flexibility with greater initial involvement (due diligence) required by the owner (investor).”

A bespoke construction solution demands the “conscious participation” of its owner. However, it may be the only way to effectively deliver on one’s unique investment goals.

“If you need a single-storey, four-bedroom house with a spacious yard, why would you settle for a triple-storey, two-bedroom townhouse because your builder can only build this product?”