Managing an investment portfolio, whether as an individual investor, as a financial advisor or a portfolio manager on behalf of investors, it is a very complicated and challenging task to perform!
There are many risks of failure to be avoided, underperformance is always a possibility, you need to balance risks of success against the risks of suffering losses. Avoiding big losses is critical, and achieving success is a slow, long-term process which is difficult to achieve.
Some of the keys to success are consistency, long-term thinking, a focus on the details, and the ability to adapt to changing circumstances.
These characteristics of success in managing investments reminds us of another notoriously difficult job: managing a professional football club!
We see many similarities between the way to construct a successful investment portfolio to the way a successful football manager, like Pep Guardiola at Manchester City, manages a successful Premier League winning team.
Pep Guardiola would never start a game with 11 strikers on the pitch, neither would he start a game with 11 defenders. Instead, he will start with some defenders, one goalkeeper (of course), perhaps five midfielders, and one striker. When Pep does this, much like an investment portfolio manager, he is balancing risk and reward, with a successful outcome in mind. For Pep, he wants to avoid losing by conceding no goals (ideally), or at worst only conceding a few goals, while also maximising the probability his team scores many goals and wins the game.
When we construct an investment portfolio, we should be doing the same thing! Retail investors should be thinking the same way too. The line-up of a football team is a helpful guide here.
An equity portfolio has its equivalent of goalkeepers and defenders, we even call them ‘defensive’ investments. These are lower risk, reliable, preferably high-quality investments which like defenders on a football team may not score any goals at all. These investments will not transform your life with incredible, 10x returns, but these investments offer limited downside risk, predictable positive price appreciation, and often predictable income flows in the form of dividends which are dependable. You have high confidence in, and can rely on, your ‘defensive’ investments.
Just like Pep Guardiola, you don’t want your entire team, your entire portfolio, to be made up solely of ‘defensive’ investments either, but you want a solid group of them to defend your investment portfolio, especially during periods of uncertainty and market volatility.
When Pep Guardiola fields his star striker Erling Haaland, he’s doing so with only one thing in mind. Haaland is a striker, he is on the pitch to score goals. He’s not there to defend, to offer protection during the bad times, he is there to win the games for the team.
An investment portfolio needs some strikers, and just like a football team, you don’t want or need too many strikers either. As a manager, you need to get your striker selection right, and if you do, you don’t need many of them on the pitch. Just as with strikers at a top football club, a small number of investments with the potential to deliver very high returns can ‘win you the game’.
If you had bought Amazon stock in 2001, today you would have a 200x return on that investment, that is a +20,000% return. If 2% of your portfolio in 2001 had been invested in Amazon, the rest of your investments could have done nothing over the past 22 years, and you would still have increased your total wealth by c. +400%.
And it’s not only technology companies offering these types of portfolio transforming returns. Monster Beverage, maker of energy drinks, if you had bought its stock in 2005, today you would have made an 84x return, an increase in value of your investment +8,400%.
Even relatively small investment allocations in your portfolio to potential ‘match winners’ who could, if your investment thesis is right, deliver extraordinary returns, can transform your total investment returns for the entire portfolio. Just like a top striker scoring the winning goal.
We even have the equivalent of midfielders in a correctly constructed equity portfolio. These are, just like midfielders on a football team, performing important roles in between defensive and attacking, and some are more ‘defensive’, while others are more ‘attacking’. These investments provide an important balance between our ‘very defensive’ and ‘very attacking’ investments, some could even ‘win the game for us’ by delivering exceptional returns. Maybe not an 84x return like Monster Beverage, but perhaps a +2x or +4x return, this can still make a big difference to a portfolio with an allocation of 5% or 10% to investments like this.
Just like Pep Guardiola, the process of putting all of these positions together to create a ‘team’, as portfolio managers we are building our ‘portfolio’ of names, which can deliver success through a mix of investments performing different roles which together can deliver successful total returns over the long-term. This is the job of the active portfolio manager!
As a final note this week, as a life-long Manchester United supporter it pains me to have to use the manager of Manchester City in this case study for successful management skills.
Hopefully I don’t have to wait too long before I can use a current Manchester United manager as a prime example of management success.