Ann: Change in substantial holding , page-5

In a previous response to a query from a HC member, Australian Ethical said in a condescending way that they were selling to balance their portfolio as all good investment managers should do.

The basis for their action is that if a share's price goes up its percentage of the total funds exceeds a threshold (percentage of total invested funds) that is inconsistent with their diversification (i.e. risk management) rules or strategy.

It is a strategy taught in management schools based on simplistic but flawed logic. As you can guess, the logic is an extension of the 'don't put all your eggs in one basket' philosophy. It has a simplistic appeal to shallow thinkers, the inexperienced, and wanna-be investment advisors.

By deduction, if they (Australian Ethical) sell TIS to reduce its percentage of the total, then they have to then purchase other shares to replace them. If the portfolio was originally at a .preferred. structure, then Australian Ethical have to purchase, as a result of their rules, some shares that are less preferred to TIS.
Result? Purchase of poorer quality shares!

Another scenario is that if Australian Ethical shares in company XYZ fell to a low value, it would promote in percentage terms the relative value contribution of other shares including TIS in the portfolio, and some may get pushed beyond the allowable percentage threshold. What would Australian Ethical do then to apply their 'diversification and risk management" rules? They would have to sell the other shares, including TIS, to reduce their proportion, and re-balance, even though TIS and others have done nothing to deserve a sell-off.
Result? Retention of falling value shares and selling of higher quality/value potential shares and !

The increase in value of TIS shares should be a validation of Australian Ethical's decision to purchase and to sell when their decision to purchase has been proven correct is not logical, given that any normal investment decision of these funds would be as a medium to long-term hold and not speculative. Selling of an asset based on its percentage of one's total assets shows that the fund managers don't have confidence in their longer term planning and investment decisions and want to take a speculative profit when it occurs instead of making it a long term accumulative investment.
Result? Small short term gains instead of larger and compounding long term returns.

Perhaps it is done because the profit makes the P&L (and the fund managers) look good in the short term (and the B/S, which sets the value of the fund and shareholder equity, is of secondary importance).

Essentially the theory of diversification and its practical result in having to 'balance' portfolios is a poor man's method of risk management, capable of being applied by any high school student and unworthy of the high fees charged by fund managers.

True risk management requires good research and constant monitoring of each Company's results, management quality, actions and market environment.

Australian Ethical's simplistic approach to what it sells as "risk management" can easily be a detriment to its investors if it is applied in a formula-driven way which appears to be the case. Unfortunately it is paraded to investors as a sensible and somewhat esoteric investment management philosophy.

'Re-balancing' is neither thoughtful risk management nor sound investing.