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PortfolioStrategy

Portfolio Strategy

Why Does Portfolio Construction Matter?

There are many asset classes available to investors these days, but choosing the right ones for your portfolio can be difficult. Learn more about why portfolio construction matters below.

Investment Strategy
Investors Typically Own What Is Most Familiar To Them

Many investors rely on a limited number of assets as they build their portfolios. They tend to think that accessing a range of equities from various countries or regions represents diversification. We believe that this approach does not go far enough. The historical returns of regional equities have often been similar to one another.

To see historical results, select two regions and watch $10,000 grow. 

ASSET CLASS
ANNUALIZED PERFORMANCE
ANNUALIZED VOLATILITY
Make another selection
Global Equity
Asia Equity
Europe Equity
US Equity
UK Equity
Historically, pairs of regional equities have shared similar peaks, troughs, and returns.
To see this performance effect across other styles go back and select two more.
SEE THE RESULTS
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Portfolio Construction

Historical Performance in Context

The coloured bars represent the annual returns of asset classes, ranked from best to worst.

Global Equity
Global Bonds
Untitled
Alternatives
Asia Equity
Commodities
Emerging Market Debt
Emerging Market Equity
Europe Equity
Global Bonds
Global Equity
Global High Yield Bonds
Global Infrastructure
Global Real Estate
Global Small Cap Equity
Local Emerging Market Debt
UK Equity
US Equity

Source: GSAM as of 12/31/2016. Past performance does not guarantee future results, which may vary.

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Emotional Investing

In keeping with the classic investment adage “it is hard to time the market,” forecasting which investments to own, and when to own them, can be difficult. To examine investors’ timing decisions, we can use mutual fund cash flows as a window into how investors move in and out of their investments. Fund flows suggest that investors may have missed out on the full return potential of some asset classes as a result of their timing decisions. This timing effect is the "investor return gap," shown in light blue.

In other words, the investor return gap is the penalty the average investor bears by entering and exiting investments at the wrong times compared to the average investment manager, who generally stays invested for the long term.

For example, as shown by the first bar, the average investor in Japanese Stock reaped 6.4% (dark blue), but missed out on an additional 2.8% due to timing decisions (light blue), since the average manager achieved a 9.1% return (dark blue + light blue).

Average Fund Returns (2012-2016)

Large Investor Return Gap
2,8%
Average Investor Return Gap
1,8%
Small Investor Return Gap
0,8%
Source: GSAM, Morningstar as of 12/31/2016. For illustrative purposes only. Past performance does not guarantee future results, which may vary. Manager return is the arithmetic average of the net returns of every fund in the Morningstar category or categories that represent a given asset class. Investor return is the average money-weighted return of the funds in the Morningstar category or categories that represent a given asset class. The investor return statistic accounts for flows into and out of the mutual funds. The difference between manager return and investor return is referred to as the investor return gap, or shortfall. The asset class Emerging Market Debt is represented by the Emerging Markets Bond category. The asset class High Yield Bonds is represented by the High Yield Bond category. The asset classes Preferreds & Convertibles are represented by the average of Preferred Stock and Convertibles categories. The asset class Global Small Cap Value is represented by the average of Foreign Small/Mid Value and US Small Cap Value categories. The asset class Global Real Estate is represented by the Global Real Estate category. All categories used are US open-end fund categories due to data availability.

Risk Managed Investing

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Seeking to Improve Return and Reduce Risk

Returns of various €1 Million Illustrative Portfolios

Traditional
Account Value after 20 Years
$3,349,220
Volatility (Risk)
7.8%
Diversified
Account Value after 20 Years
$3,656,935
Volatility (Risk)
7.5%
More fully Diversified
Account Value after 20 Years
$3,575,060
Volatility (Risk)
6.4%
Source: GSAM as of 11/30/2015. The time period of trailing 20 years was chosen indicate a long investment horizon that might capture many market environments.
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What Tools May Help Diversify Portfolios?

Given the uncertainty pervading the current equity and interest rate environment, we believe now is a particularly important time to consider diversifying portions of traditional portfolios. Although specific allocations may vary over time, we view diversification as a long-term effort. Today, for many investors, this may be easier to accomplish than ever. Investors can access a number of diversifying and alternative strategies in broadly available investment tools such as mutual funds and exchange-traded funds.

Home-Country Bias

Diversifying Strategies

Diversifying Investments: A Primary Tool

There are many tools that can potentially be used to diversify a portfolio. A "diversifier" is defined as a complement to an investor's traditional, or core, portfolio. Their risks have tended to diverge from the risks of core equities. Incorporating diversifiers into a well-balanced portfolio potentially enables investors to access several different sources of risk and return.

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Core Strategies

Seek to potentially provide exposure to asset classes that are broadly representative of the market

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Diversifying Strategies

Have the potential to increase returns and reduce risk by tapping into differentiated markets

Result

More efficient portfolio construction with higher return potential and increased diversification

Diversifiers Explained

Diversifiers are asset classes with attractive return potential and historically lower correlations when compared to core investments such as investment grade fixed income and most equities of developed markets. We believe the diversifiers below can be deployed in search of improved returns or lowered risk, and may help build more balanced portfolios.

For illustrative purposes only. Diversification does not protect and investor from market risk and does not ensure a profit. The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk. There is no guarantee that these objectives will be met.


Alternative Investments

An Effective Tool for Risk

Alternatives are an additional tool that can potentially be used to diversify a portfolio. Alternative strategies may complement an investor’s traditional portfolio by employing tools such as shorting and/or leverage. Incorporating alternatives into a well-diversified portfolio potentially enables investors to access a differentiated source of return, lower the overall risk of their portfolios, and provide shallower drawdowns during market crises.

Traditional
RETURNS
7.5%
VOLATILITY
10.7%
With Alternatives
RETURNS
6.8%
VOLATILITY
8.4%
Median returns and volatilities for 10-year rolling periods from January 1, 1990 to June 30, 2015
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See How Alternative Strategies Might Affect Your Portfolio

Use this tool to explore the potential benefits of adding alternatives to a hypothetical portfolio.

LAT

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CONTACT US

For More Information
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+34 91 700 6000
Funds Client Service
+44 20 7774 6366