Investment Methodology

A robust investment methodology behind the discretionary management of client portfolios.

We strive to serve you as the most advanced digital investment adviser in Australia. We stress the academic prowess of an investment idea or concept, enabling us to serve our clients as a high-quality investment management service.

Our investment approach encompasses:

  • Determining the risk tolerance score of clients
  • Determining the recommended asset classes
  • Determining the optimal mix of asset classes
  • Identifying suitable ETFs for each of the asset classes
  • Constructing customised portfolios based on the risk tolerance score of clients
  • Continual reassessment of the composition of QuietGrowth portfolios
  • Rebalancing and continuous management of client portfolios

We adhere to the Chicago School of Thought in our portfolio management methods. Its influence on our investment methodology is due to its time-tested, data-driven effectiveness and because our founder, Dilip Sankarreddy, was trained at The University of Chicago Booth School of Business in Finance.

1. Determining the risk tolerance score of clients

We believe that sophisticated algorithms can in some respects do a better job of evaluating the risk tolerance score of a client, compared to how an average human financial adviser evaluates the risk tolerance score of that client. If the scope of the problem statement is limited to long-term risk-optimised investing, then the effectiveness of these high-quality algorithms can be on par with the effectiveness of a high-quality human investment adviser.

The client's risk tolerance score that we determine considers both the objective risk tolerance and the subjective risk tolerance. Some questions in the questionnaire will be based on objective risk to determine the ability of the client to take risk, and the rest of the questions will be on subjective risk to determine her willingness to take risk. We will also identify and factor in any inconsistencies in the manner in which the client answers the questions pertaining to subjective risk tolerance.

Our methodology to determine the risk tolerance score of the client has various aspects such as:

  • Objective ability of the client to take risk based on her projected savings after expenses throughout her working years, projected retirement income, and projected retirement spending needs.
  • Subjective willingness of the client to take risk.
  • Consistency of responses given by the client to the questions used to determine her subjective risk tolerance score.

We ask objective questions to determine whether the client is in line towards her saving enough money to afford her likely spending needs for the rest of her life. This also helps us in partly determining how much risk the client can take with her investments.

We also ask subjective risk questions to determine the level of risk a client is willing to take. Understanding the attitude of the client towards risk is important because ultimately the client needs to be comfortable with the risk element of her investment plan.

Analysing the consistency of the answers given by the client for the subjective risk questions helps us to know whether the client understands the questions that we ask. For example, if the client is willing to take a significantly higher risk as per her response to one subjective question, and is willing to take a much lower risk as per her response to another subjective question, then she is inconsistent in her answers. Due to this inconsistency, we might assign a lower subjective risk tolerance score than she would have got otherwise.

1.1 Comprehensiveness of risk tolerance score questionnaire

We have designed our client risk tolerance score determination methodology in such a manner that a minimum number of questions are sufficient to determine the risk tolerance score of the client to a reasonable accuracy. We are mindful of the number of questions we ask, and intend to ask as few questions as possible. We believe that our well-thought list of questions is sufficient and highly effective in identifying the risk tolerance score of a client accurately.

After we create the QuietGrowth account for the client and the client starts investing, we will continue to gather more information about her so that the accuracy of our understanding of her risk tolerance score improves progressively.

1.2 Rainy-day fund

We recommend that the client should set aside the requisite money for a rainy-day fund in term deposits, low-risk fixed-income instruments or cash. If the rainy-day fund comprises a small portion of higher-risk equity exposure, then such instruments should be highly-diversified. It should cover at least six months of expenses to deal with any unexpected emergencies (such as unemployment, illness) that might arise in the lives of the client and the dependent family members. The rainy-day fund would also include six-month's worth of any monthly payment commitments that the client might be having towards mortgages, loans or insurance premiums.

The client should not try to maximise the return-on-investment for her rainy-day fund. Instead, the client should ensure that her rainy-day-fund is less risky and is liquid. The probability of the rainy day fund losing a sizable portion of its value should be low, and the probability of having a high volatility in its day-to-day value should be low.

In case a client cannot afford to set up a rainy-day fund, then we take that into consideration while determining her risk tolerance score. Refer to our knowledge resource 'What is a rainy day fund?' for more information.

1.3 Proportion of your savings in QuietGrowth portfolios

We believe that you can invest all your savings for the long-term in the QuietGrowth portfolios, as per the advice we provide you in our Statement of Advice (SOA), after you set aside the requisite money for (a) a 'rainy-day fund'; and (b) an optional 'discretionary fund'.

We consider all the venture bets that you make are a part of your discretionary fund.

1.4 Loans with high-interest rates

We recommend that the client repay all the outstanding loans that have high-interest rates before she considers investing for the long term. Credit card loans, personal loans, overdrafts, buy now pay later loans and payday loans are certain types of credit that typically have high-interest rates.

Also, we do not recommend the client take a loan to invest for the long term in QuietGrowth Portfolios. We believe that the magnified returns due to leverage can be challenging to sustain over the long term.

2. Determining the recommended asset classes

The first step in our methodology is to identify a broad set of diversified asset classes. The availability of various Exchange Traded Funds (ETFs) traded on the relevant exchange is also factored in when identifying the asset classes. We evaluate each asset class on its potential for capital growth, income generation, volatility and correlation with the other asset classes, which can be referred to as diversification. We also consider inflation protection where relevant, and the cost to implement the portfolio using ETFs for these asset classes. We attempt to determine the asset classes in our portfolio in such a manner that the various asset classes are relatively uncorrelated, where appropriate.

We consider the securities traded on the Australian Securities Exchange. The funds we choose together track a wide spread of indices and underlying assets, thereby reducing risk via diversification.

We adopt minimum and maximum allocation constraints for the growth and defensive components of our multisector portfolios. We consider equity and property asset classes as part of the growth component of the portfolio. We consider bonds, cash and precious metals such as gold as part of the defensive component of the portfolio. We consider natural resources or commodities other than precious metals as part of either growth or defensive components, depending on the nature of that natural resource.

The asset classes that you presently gain exposure to through QuietGrowth portfolios are:

  • Australian shares
  • Developed markets excluding Australia shares
  • Emerging markets shares
  • Dividend shares
  • Bonds
  • Natural resources such as gold

The asset class representing an additional investing strategy that you presently gain exposure to through QuietGrowth portfolios is:

  • Australian high dividend shares

As we add more asset classes to a portfolio, it gets more difficult to achieve further improvement in the risk-return tradeoff. It is a case of diminishing returns. In this context, we still explore including additional asset classes that are suitable.

We prefer separate equity ETFs for 'developed markets excluding Australia' and 'emerging markets' instead of a single equity ETF for 'world excluding Australia'. This preference enables us to control more effectively the attributes, such as risks and returns of each of our portfolios.

2.1 Same asset classes for everyone

The same set of asset classes apply to everyone. We do not believe that a client should not have exposure to a specific asset class.

2.2 Thematic portfolios

We do not build QuietGrowth Portfolios as thematic portfolios. QuietGrowth Portfolios do not have deliberate exposure to a long-term macroeconomic theme or trend because it is tough to predict the outperformance of such a theme or trend. Often, most of the future growth of a trend and associated risks are already factored in the current valuation of public companies operating in that trend.

Some of the prominent themes we consider in our analysis are:

  • Rapid urbanisation
  • Climate change
  • Aging population
  • Cyber security
  • Space exploration
  • Cloud computing
  • Artificial intelligence
  • Environmental, Social, and Governance (ESG)
  • Disruptive technologies in robotics, biotech, semiconductor, blockchain, etc.

If you adopt the core-satellite investing approach, then QuietGrowth portfolios can serve as the 'core'. You can consider having thematic investments of your choice as a part of the 'satellite'.

For more perspective on ESG, refer to the 'Ethical investing' section further down in this 'Investing methodology'.

Refer to our 'An introduction to thematic investing' knowledge resource for more information.

2.3 Sector portfolios

QuietGrowth Portfolios are not sector-based portfolios. QuietGrowth Portfolios do not have extensive exposure to a specific sector, with an expectation of that sector outperforming the broad market indices in the short term. This is because it is tough to predict the outperformance of a specific sector.

Some of the prominent sectors we consider in our analysis are:

  • Consumer discretionary
  • Consumer staples
  • Energy
  • Financials
  • Healthcare
  • Industrials
  • Information technology
  • Materials
  • Real estate
  • Telecommunications
  • Utilities

Our portfolios do not currently have the real estate or property REIT asset class. We prefer the equity asset class to this sector asset class in the growth component of our portfolios. We may include this asset class for a specific period if we believe that the Australian or global REITs have a good growth story in the medium to long term.

If you adopt the core-satellite investing approach, then QuietGrowth portfolios can serve as the 'core'. You can consider having sector-based investments of your choice as a part of the 'satellite'.

Refer to our 'An introduction to sector investing' knowledge resource for more information.

2.4 High dividend investing strategy

We prefer the high dividend yield shares as an asset class in QuietGrowth portfolios. At present, we have adopted this investing strategy.

Dividend shares are usually companies that are large-cap, with sound business practices and in less cyclical industries. Hence, they are usually less volatile than other shares. So we believe it is preferable to get exposure to companies offering high dividend yields, especially during volatile times. Many companies in this asset class often have higher dividend yields than their corporate bond yields and the bond yields of the government where these companies are based. As an asset class, high dividend shares offer a reasonable income stream with a capital growth potential.

In addition to the equity market risk, high dividend shares are subject to the risk of these high dividend shares underperforming the broad stock market.

Refer to our 'An introduction to high dividend investing' knowledge resource for more information.

2.5 Small-cap, mid-cap and large-cap strategies

We do not prefer small-cap, mid-cap or large-cap investing strategies. Instead, we believe that the broad-based equity indices in each geography ably represent the opportunities and risks of small, mid and large-cap firms of those geographies.

2.6 Growth and value investing strategies

We do not prefer growth versus value investing strategies. Instead, we believe that the broad-based equity indices in each geography ably represent the opportunities and risks of growth-oriented and value-oriented firms of those geographies.

2.7 Bond strategy

QuietGrowth Portfolios, built with a long-term perspective, include both short-term bonds and long-term bonds. We prefer more exposure to high-quality bonds, such as government bonds from stable countries, than lower-quality bonds. Our preference to target a higher yield by opting for lower-quality bonds is limited — because capital preservation is more important to us than chasing yield while investing in bonds.

Refer to the following knowledge resources for more information:

2.8 Hedge funds

QuietGrowth Portfolios do not include hedge funds, as of now. Not all hedge funds are equal, and it is not preferable to invest in a hedge fund, just because that fund happens to be a hedge fund. Like most of the other alternate investment opportunities, it is prudent to stay away from most of the hedge funds, except for certain hedge funds that are best-in-class. However, it is difficult to participate in such high-quality hedge funds, especially with favourable terms of participation so that the interests of QuietGrowth clients are catered to. So, whenever QuietGrowth gets an opportunity to participate with favourable terms in these high-quality hedge funds, we will certainly consider.

Refer to our 'An introduction to hedge funds' knowledge resource and 'An introduction to alternative investing' knowledge resource for more information.

2.9 Private equity funds

QuietGrowth Portfolios do not include private equity funds, as of now. Not all private equity funds are equal, and it is not preferable to invest in a private equity fund, just because that fund happens to be a private equity fund. Like most of the other alternate investment opportunities, it is prudent to stay away from most of the private equity funds, except for certain private equity funds that are best-in-class. However, it is difficult to participate in such high-quality private equity funds, especially with favourable terms of participation so that the interests of QuietGrowth clients are catered to. So, whenever QuietGrowth gets an opportunity to participate with favourable terms in these high-quality private equity funds, we will certainly consider.

Refer to our 'An introduction to private equity' knowledge resource for more information.

2.10 Private companies and startups

QuietGrowth Portfolios do not include shares in private companies. We believe that the determination of the share price of a private company is less efficient compared to that of a publicly listed company. The liquidity of such an investment is typically lower. So, QuietGrowth would consider investing in private companies only when we build the capabilities to assess the investment opportunity of owning shares in a private company.

QuietGrowth Portfolios do not include shares in startups that are not public companies. We believe that investing in such startups should be done using the 'play money' of the client.

Refer to our 'Startup Investing' knowledge resource for more information.

2.11 Cryptocurrencies

We recognise cryptocurrencies as an asset class. However, we have decided to exclude, as of now, this asset class in the construction of our portfolios. We believe that, as of now, investing in cryptocurrencies is a venture bet. Refer to our opinion 'Investing in bitcoin, other cryptocurrencies and NFTs' for more information.

We are against the idea of investing in cryptocurrencies through your SMSF. Your superannuation wealth is critical to your quality of life post-retirement, and hence it is not prudent to expose your superannuation wealth to these venture bets.

We believe that Efficient Market Hypothesis does not hold good for any of the cryptocurrencies, as of now. The underlying technologies of cryptocurrencies are fast evolving and esoteric. The utility of some cryptocurrencies, especially bitcoin, deriving from their positioning as a store of value is yet to pass the test of time. The utility of each of the cryptocurrencies is a venture bet on its "concept of the future".

2.12 Wine

We recognise wine as an asset class. However, we have decided to exclude, as of now, this asset class in the construction of our portfolios.

Refer to our 'An introduction to wine investing' knowledge resource for more information.

2.13 Non-Fungible Tokens (NFTs)

We recognise NFTs as an asset class. However, we have decided to exclude, as of now, this asset class in the construction of our portfolios.

2.14 Digital assets in the metaverse

We recognise digital assets in the metaverse as an asset class. However, we have decided to exclude, as of now, this asset class in the construction of our portfolios. We believe that, as of now, investing in digital assets in the metaverse is a venture bet.

3. Determining the optimal mix of asset classes

Efficient Market Hypothesis influences our investment methodology approach. We follow evidence-based investing principles and aim for risk-optimised long-term growth. In this direction, we acknowledge the significance of the Fama/French school of thought. We aim to gravitate towards the Efficient Frontier associated with Mean-Variance Optimisation (MVO), the foundation of Modern Portfolio Theory (MPT). After determining the asset classes, we calculate the optimal mix of those asset classes using various analyses. Macroeconomics plays a substantial role in our analyses. We also evaluate the historical performance and expected behaviour based on asset pricing theories for each asset class. We try to discern the future market conditions.

The goal is to create each portfolio by determining an optimal mix of asset classes to maximise the expected return for a specific level of given risk. This risk is as determined for each client. The other way of looking at this goal is to minimise the risk for a specific expected return of the mix of the asset classes. For this reason, the intention is to calculate the best risk-return trade-off by finetuning the mix of asset classes.

The same mix of asset classes applies to everyone with the same risk tolerance score.

Refer to the following knowledge resources for more information:

4. Identifying suitable ETFs for each of the asset classes

We prefer to use ETFs to track the indices of various asset classes in our portfolios. We believe that the ETF is the most suitable type of financial instrument to get a broad exposure to an asset class. We observe that usage of ETFs is an effective way to achieve diversification, by gaining exposure to a wide variety of underlying assets.

We prefer ETFs with low annual expense ratios, minimal tracking error, low bid/ask spread costs, sufficient liquidity and minimal lending of the underlying securities of the ETFs. ETFs that are traded on Australian Securities Exchange (ASX) and ETFs that are domiciled in Australia are preferred. We are transparent about the reason for us selecting one ETF over the rest of the ETFs catering to the same asset class.

We prefer using separate ETFs in portfolios instead of a multi-asset ETF which consists of unlisted managed funds.

We might choose more than one ETF in an asset class if we are of the opinion that there is no one single ETF available that can comprehensively represent that particular asset class.

Refer to our 'ETF Investing' knowledge resource and 'An introduction to Exchange Traded Fund (ETF)' knowledge resource for more information.

4.1 Same ETFs for everyone

Because the same set of asset classes apply to everyone, the ETFs that represent those asset classes are the same for everyone.

4.2 Hedged versus unhedged securities

We prefer unhedged securities for international equity and commodities while preferring hedged securities for international bonds.

We believe that a global portfolio with exposure to different international asset classes should have exposure to currency risk instead of hedging against currency risk. The main reasons are:

  1. Unhedged exposure allows aiming for diversification across different currencies.
  2. The product issuer incurs an extra cost so that the hedged security implements the hedging instrument. The product issuer might pass on this extra cost to the investor in the form of an increased expense ratio. Usually, this extra cost is a few basis points per annum.

However, we prefer hedging for an asset class that we expect to provide fixed income, such as international bonds.

Refer to our 'Hedged versus unhedged currency risk exposure in investments' knowledge resource for more information.

4.3 Ethical investing

While identifying suitable ETFs for each asset class, we do not give particular preference to Ethical ETFs or ESG ETFs. The metrics that we use to select an ETF apply to Ethical ETFs too. Hence, none of the Ethical ETFs has become a part of QuietGrowth Portfolios so far — mainly because Ethical ETFs have higher expense ratios, lower diversification and no exposure to certain high-performing public companies.

Suppose you are inclined toward socially responsible or ethical investing. In that case, you can consider our 'alternative to investing in ethical funds' suggestion described in the 'Ethical Investing' knowledge resource.

We are cheering for the further evolution of ESG ETFs traded on ASX.

4.4 Smart Beta investing

We recognise the effectiveness of Smart Beta strategies in numerous scenarios. We believe that we can include Smart Beta ETFs in our portfolios, if these strategies have been proven to be effective in the past, and if we determine that there is a high probability that these ETFs continue to give desired results. It is good news that there has been an increase in the number of various Smart Beta ETFs, as it helps us to choose from a broader choice-set of Smart Beta ETFs. We monitor this emerging class of ETFs closely, and there is a possibility of including Smart Beta ETFs in our portfolios at an appropriate time.

4.5 Leveraged securities

We do not use leveraged securities such as leveraged ETFs and leveraged inverse ETFs in QuietGrowth Portfolios. We believe one of the reasons leveraged securities are unsuitable for long-term investing is that the magnified returns can be challenging to sustain over the long term.

4.6 Target-date funds

We do not use target-date funds in QuietGrowth Portfolios. We believe that there is no need to use target-date funds in our portfolios. The reason is that the client's need for a risk-optimised return over the long term is already met by our portfolios which consider the client's financial circumstances, including her age.

5. Constructing customised portfolios based on the risk tolerance score of clients

The different characteristics of each asset class can have a significant impact on the performance of the portfolio of the client. Diversification is a major factor in our philosophy. This is because specific asset classes generally perform differently as market conditions change.

We adopt minimum and maximum allocation constraints for each of the asset classes. This is to achieve appropriate portfolio diversification, to mitigate any estimation errors, and to factor in the client preferences.

5.1 Risk portfolios

We offer five different risk portfolios. Each of our portfolios is optimised to a specific risk profile of the client. The risk of our portfolios ranges from lower risk to higher risk, and the five portfolios are named as 1/5, 2/5, 3/5, 4/5 and 5/5 in increasing order of risk.

You can consider our QuietGrowth Portfolio 3/5 as a 'balanced portfolio' among our list of portfolios, because the risk of this portfolio is in the middle of the risk spectrum of QuietGrowth portfolios.

5.2 Investment horizon

We build risk-optimised portfolios with a long-term perspective. To enjoy the benefits of diversification of QuietGrowth portfolios in an increasing manner, the client would need to stay invested for at least 10 years. The probability of loss of the investment in a diversified portfolio decreases as the client stays invested for more number of years.

So, ideally, the investment of the client in QuietGrowth portfolios should not include those investments with a short time-horizon of a few months or a year. If the client is thinking of a big-ticket purchase, such as a house, within a year, and she cannot afford to lose a part of her money till the purchasing event because of market volatility, then she should not invest that amount in a QuietGrowth Portfolio. Instead, the client should park that money in a term deposit till the purchasing event.

5.3 Forming the core of core-satellite investing

If you adopt the core-satellite investing approach, then QuietGrowth portfolios can serve as the 'core'. The highly-diversified, low-cost nature of QuietGrowth portfolios enables you to create the core of your investments with our risk-optimised portfolios. Then, depending on your or your traditional wealth manager's preference, various other investment options, outside QuietGrowth portfolios, can serve as 'satellite' allocations.

Refer to our 'An introduction to core-satellite investing' knowledge resource for more information.

5.4 Benchmarking

We do not benchmark against any external accumulation index. This is because our portfolios are constructed without any intention to track or to outperform any external benchmark indices.

We benchmark the actual performance of a client's portfolio with a particular risk score against the comparative benchmark which is our own model portfolio with the same risk score.

6. Continual reassessment of the composition of QuietGrowth portfolios

Our investment team monitors various factors influencing the composition of our portfolios, and whenever our investment team determines that the target mix of a particular QuietGrowth portfolio needs to be altered, the portfolios of clients are transitioned to the new target mix as feasible. The decisions concerning altering the composition of the portfolios take place at least once in three months.

There can be extended periods wherein the composition of the portfolios might not change. This occurrence can be due to multiple reasons, for example, no significant change in the key drivers of the global economy or markets when viewed with a long-term perspective.

7. Rebalancing and continuous management of client portfolios

QuietGrowth monitors your portfolio for specific events and asset allocation drift to ensure that the portfolio stays within the Investment Program. This is because the asset allocations of your portfolio can drift over time from their target allocations. Rebalancing helps bring the current mix of the client's investments closer to the target mix.

7.1 Rebalancing periodically due to market changes

We rebalance your portfolio periodically whenever we see that any one of the funds in your portfolio has drifted by a certain percentage from its target allocation that is mentioned in your Investment Program. Hence the trigger to rebalance is determined by threshold-based percentage drift. We believe that this method is preferable, instead of having a predetermined period based approach (such as rebalancing once every quarter, or once every year).

We will also consider various other aspects before we rebalance, such as the cash available to rebalance, the prospect and the size of any oncoming dividends, the volatility of each fund in your portfolio, and the impact on capital gains taxation because of rebalancing. Even though QuietGrowth absorbs the trading costs incurred while rebalancing and does not charge the client for these costs incurred, we are mindful of these costs too. Hence we rebalance when the dollar amount of the buy or sell trades to be executed while rebalancing is of a meaningful amount only.

7.2 Rebalancing during specific events

We will also monitor your portfolio for rebalancing during specific events. We consider whether we should rebalance your portfolio whenever (a) you deposit funds; (b) you instruct us to withdraw funds; (c) the risk tolerance score of the portfolio is changed; (d) we change the target allocation of the portfolio; or (e) you merge another portfolio into the portfolio. We will evaluate whether we can perform threshold-based rebalancing at that time as we determine the exact buy or sell trades of various funds that we might execute.

The relative performance of each of the funds in your portfolio matters a lot towards rebalancing, and hence, we cannot predict when we are likely to rebalance your portfolio. Your dashboard will show by how much percentage each of your funds has drifted from its target allocation.

7.3 Rebalancing using the cash distributions

We prefer cash dividends or cash distributions instead of opting for a distribution reinvestment plan. The dividend and distribution amounts that are paid by different ETF issuers are deposited in your cash account. We reinvest the dividend or distribution amounts towards the purchase of securities by executing one or more buy trades. We prefer this portfolio management approach, instead of opting for a distribution reinvestment plan, because this approach allows us to attempt to rebalance your portfolio while executing those buy trades.

8. OTHER INFORMATION

Machine learning

We use machine learning technology for analysing the client data to give better financial advice digitally. We do not use machine learning for the construction of QuietGrowth Portfolios.

Other QuietGrowth resources related to our investment methodology