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A Few Elephants in the Discretionary Investing Room

Let’s get back to basics.

Active investing is a process.  Execution of this process results in short and long-term outcomes. Short-term outcomes don’t prove skill, luck plays a very material role.

In reality, most investors are not students of their process and spend little time around luck attribution.

But let’s go further into the basics.

Active discretionary portfolio management essentially consists of 2 things: 

  1. Asset selection 
  2. Portfolio Construction

 In my opinion, the reality here is:

  • Most investors spend the vast majority (>90%) of their time and effort pondering asset selection, and precious little time on optimal portfolio construction
  • For any number of ideas, there are a vast number of possible portfolios.  What is the best portfolio to maximise the risks wanted and minimise the risks not wanted? 
  • The execution of rigorous process for asset selection in some funds is strong, but on average in the industry it’s poor.  It’s very rare to find investment teams who combine it with real rigor of portfolio construction
  • Portfolio construction should not be an either/or debate between pure human judgement or black box solutions.  It needs elements of both, where the PM can easily input to, explain and understand a mathematical engine.

 2 further observations:

  • Ask a PM why they hold x basis points of one of their positions?  Greater than 9 times out of 10 they will tell you a story about the attractive features of the position, and NOT because ‘it helps to manage portfolio risk’
  • Analysts are trained to pick names but PMs aren’t typically trained to construct portfolios


Skill development in active asset management is a risk-free activity.  There is zero downside to doing it, however most don’t do it. As stated, there are 2 parts:

  • Asset selection skill involves creating your own process for your chosen philosophy and constantly enhancing this over a career and actively thinking about luck.  It requires individual hunger and support from others.
  • Portfolio construction skill requires an open mind and a maths/engineering tool that understands practical constraints and optimises for many factors, but in an explainable way. Do such tools exist? Yes.

In my humble opinion, any investment team who can prove that they are working on both with in-house or external support, will be meaningful long-term winners, not only relative to other active managers, but also versus passive investing.

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