Ask the same question to a winemaker and they'll doubtless mention a host of variables that can determine whether a wine is great, good, mediocre or undrinkable.
Quality of the grapes, the soil, the position of the vineyard, the weather, the irrigation, the timing of the harvest, ageing and bottling — just to name a few variables. The late Robert Mondavi encapsulates it well, "You can make bad wine with great grapes but you can't make great wine with bad grapes."
Investing is a bit like that. Similar levels of care are critical to good investment outcomes.
There is no doubt that we all want to see great outcomes and savour those returns. But many don't appreciate the importance of good process and attention to detail. In investment, that means asset allocation and a focus on risk and cost.
As we all know picking the grapes isn't the end of it – the harvest must be sorted, the grapes crushed and pressed, then fermented, clarified, aged and bottled. At any stage of the process, a lack of attention to detail can spoil the final outcome.
In similar fashion, investment management requires attention to detail—researching and identifying the dimensions of expected returns, designing strategies to capture the desired premiums, building diversified portfolios and implementing efficiently.
And remembering that just how winemakers don't have any say over the weather, investment managers can't control the markets. Not every harvest will produce an excellent vintage, but expert professionals can still maximise their chances of success by putting their greatest efforts into things they can influence.
For winemakers that may be taking extreme care in picking the grapes at a time that delivers the desired balance of acidity and sweetness. For investment managers, it can mean precisely targeting the desired premiums while ensuring sufficient diversification to lessen idiosyncratic risk in the portfolio.
Winemaking is as much an art as a science. While fermentation comes naturally, the winemaker must still guide the process, using a variety of techniques to ensure the wine is as close as possible in style and flavour to what he is seeking to achieve.
Similarly with investments, real world frictions mean that basing one's approach purely on a theoretical model is unlikely to be successful. For instance, trade-offs must continually be made between the expected benefits of buying particular assets and the expected costs of the transactions. Managing the effects of momentum and being mindful of tax considerations are among the other issues to be balanced.
But the comparisons don't end there.
Just as in viticulture, investment outcomes can also be affected by any number of external events – such as the imposition of capital controls in an emerging market, or changes in regulation, a severe financial crisis, or a major geopolitical event.
Dealing with uncertainty and navigating the "unknown unknowns" are part of the job. So investment managers must build into their processes a level of resilience, through diversification for instance, so they have sufficient flexibility to work around unforeseen events.
Tastes come and go
As Robin Powell from the Evidence Based Investor says, good winemakers also learn to diversify. Consumer tastes can change. In the 80s, everyone was drinking chardonnay, then sauvignon blanc took over. More recently, pinot has become the fashion. And eventually, the cycle swings back to chardonnay again.
Likewise, good investors don't pin all their hopes on one stock, sector or asset class. They mix them up because they know not every year is going to be a great vintage.
It's all in the detail
Finally, just as great wines depend on attention to small details, so do great portfolios. A good winemaker will take care to cellar his wine in optimal conditions, at the right temperature and humidity with not too much light. A good investor learns to leave their portfolio alone, apart from conducting disciplined and regular rebalancing with the help of a financial adviser.
Often great ideas do count for a lot and it is easy to overlook the benefits of discipline and attention to detail. But it is recognising that great ideas without efficient implementation can mean even the best grapes in the world can go to waste. Another reason why finding an independently certified fiduciary is not only the best thing you can do for your financial planning but also the best way to ensure that your financial adviser is truly on your side.
· Nick Stewart is an Financial Advisers and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified, independent financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
· This article is prepared in partnership with Dimensional Fund Advisors. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
