Returns bulletin

What are the ingredients of a portfolio's return?

 

The composition of returns

Do portfolio fund managers have much control over the returns they deliver to investors? The answer lies in what drives them.  

We can imagine an investment portfolio’s returns as comprised of three main components.  

First, the portfolio’s ingredients for growth – the fundamental qualities of the underlying businesses themselves. The Stock Pickers at Alliance Trust spend a lot of time identifying companies with strong fundamental characteristics that set them up for business success. This could be looking for solid balance sheets, or plentiful cashflows that repeat year after year, or stable earnings that are on an upward trajectory. It is these sorts of companies that are much better positioned to grow their profits long into the future – a strong driver of share price returns. 

Second, the portfolio’s investing activity – how the fund manager trades within the market they operate. Given the ever-changing nature of markets and economies, fortunes rise and fall for companies and their operations. The managers will constantly re-evaluate the market depending on changing conditions to ensure the portfolio contains the best companies with the strongest fundamentals from across the market, or those with the widest margins between their share prices and intrinsic values, trading in and out of positions where necessary. 

Third, short-term and short-lived market sentiment, which may unfairly reward or punish certain parts of the market depending on what is going on in the wider macro-economic and geopolitical environment. Indeed, this final component is one that sits outside of the control of the fund manager (or indeed anyone!), and yet it can be the most impactful on share prices when markets panic.  

How Alliance trust approaches investing

While the waxing and waning of market sentiment may impact short-term performance, to our managers this is often seen as an opportunity to purchase attractive companies at even better prices. More broadly, the Stock Pickers of Alliance Trust believe in focusing on what is in their control: finding companies with strong underlying fundamentals, as it is these characteristics that serve the long-term investor well. 

Indeed, if we look at the total return of markets over very long periods of time – more than 100 years – we can see how closely prices track the improving fundamentals of underlying companies. 

Source: http://www.econ.yale.edu/~shiller/ 

In the Alliance Trust portfolio, we can see the fundamentals of the underlying companies are looking particularly strong in comparison to its benchmark. Of course, while it’s no guarantee of future performance, it certainly gives the portfolio the best opportunity for delivering strong returns to its investors over the long term.  

Marcus De Silva is a Freelance Investment Writer

 The views expressed are the opinion of the Managers and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as at September 2022 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.