We sat down with Kristopher Heck, Managing Partner and our Chief Investment Officer, to ask him about the Tanager investment philosophy, and how it works over time through various market conditions.

What is the Tanager Wealth Management investment philosophy?

At Tanager Wealth Management our investment philosophy is based on academic research and evidence which strongly suggests that, over time, an investment portfolio is more likely to be successful by holding a broad collection of diversified, low-cost, index funds and combining this with appropriate asset allocation. We believe this is favorable to picking individual stocks or fund managers over a mid to long term investment horizon.

We build a bespoke investment portfolio for each of our clients that aligns with their personal financial goals and future needs. Many of our clients are saving for retirement, for children’s education, a second home, or simply to create a legacy.  We look closely at what we can do to generate that level of wealth for that client over the relevant time period and help them achieve their goals.

Increasingly we also incorporate the client’s ethical values into their portfolios by investing along Environmental, Social, and Governance (ESG) dimensions. These clients may not wish to invest in gun manufacturers, for example, or tobacco stocks. Our values aligned portfolios have been a staple for our clients for several years now, and are achieving that alignment.

Finally, we strive to be as cost and tax-efficient as possible as costs are one of the biggest hurdles to long-term investment success. Numerous studies have shown, in fact, that costs, both transparent and hidden, are the main determinant of investing success over the long term.

What costs should investment clients of Tanager Wealth Management be aware of?

1. Platform and transaction costs are the costs of owning, buying and selling investment products inside of your portfolio, and are often forgotten by investors. Minimizing these over time is a core tenet of our structured investment process.
2. Product costs such as the asset or fund manager charge for a collective investments like a mutual fund or an exchange traded fund. It is important to remember that every percentage you can save in fees is a percentage more return that you get to keep for your retirement.
3. Tax costs are also frequently ignored. For example, an investment that generates returns via high dividends would create a higher income tax rate for a client than an investment generating returns through capital gains. This is especially important to think about as Tanager clients tend to pay taxes in multiple countries, so we have to be aware of the intersection of these different tax rates. An investment that is tax efficient in the UK might not be tax efficient in the US and vice versa.

How do you set the asset allocation for the model portfolios and then select your funds?

We set a target asset allocation that we believe will generate a good risk-adjusted return after fees and taxes. For, example, if we think that 5% should be in Asian companies, we will research what we believe to be the best product to fill that allocation.

We have a range of model portfolios that cater for our different clients’ residency or tax status. For example, someone like me, who is a US expat and has moved to the UK, will have a different portfolio compared to a local British person who doesn’t pay US tax, such as my wife. Within the asset allocation and client type, we will recommend a portfolio that accomplishes the objective in the most cost-efficient way possible.

Our portfolio construction tends to rule out most traditional active funds, based on cost and well documented research that suggests that active managers fail to consistently beat the market over time.  However, some asset classes are not well served by index funds and we are not zealots to the index based approach.

For example, a senior loan index does not tend to reflect the opportunities in that asset class. Also, for higher risk and return asset classes, such as small-cap or emerging-market stocks, you might be better served having a fund that doesn’t follow the benchmark. Tanager will source the best fund for the asset class to achieve the client’s investment objective.

How many model portfolios does Tanager Wealth Management have?

In general, we maintain one set of asset allocations for equity investments and one set for fixed income investments.  Each client will fit into 1 of 5 risk levels that determines the aggressiveness of their investment portfolio and how much equity or fixed income we blend to achieve that risk/return profile. A client who chooses the lower end of the risk spectrum will have a more conservative approach to their investments, while someone on the higher end will invest with an approach that has more potential upside.

There are many different parts of the initial client fact-find, that will be explored to decide what the risk-reward profile of a client portfolio will be. In essence, an individual or household’s investment approach, goals, pre-existing holdings, and tax status will define the type of funds that will go into a portfolio. ESG investing adds another facet of criteria for the portfolio, and choices are available to eliminate investments that are not aligned to a client’s values.

What does rebalancing a portfolio mean?

Rebalancing a portfolio is when you review a portfolio and see how it has drifted from the initial asset allocation over time and re-allocate to return the portfolio to its correct asset allocation.

For example, if you invested all your money in a portfolio split 50:50 between fixed income and equities 10 years ago, it is likely that, without rebalancing your portfolio is now split 75:25 and as a result you are now over-exposed to equities which means you are out of line with your pre-agreed risk profile.

Rebalancing, therefore, is when you periodically bring your portfolio back to its target risk and asset allocation. It essentially helps to you make sure the portfolio is still aligned to what you need to reach your long-term goals. Rebalancing and diversification are two ways of ensuring risk control in the portfolio.

Tanager Wealth Management is a UK based company; do you invest in UK businesses?

We actually have offices in both the US and the UK. We do invest in UK companies as part of our diversified approach to investing. We are careful however, to not exhibit a UK home-country bias, which a local stockbroker or discretionary manager might exhibit. Broadly speaking, we invest in line with how the global market capitalizations are represented in major benchmarks. The UK represents only 6-7% of the global capital markets, so a portfolio with higher exposure to the UK would mean that your portfolio is “overweight” UK companies. For example, by investing in an index based Europe ETF, a proportion of that will be made up of UK stocks. We just would not lean towards only investing in UK stocks and businesses.

You use the word ‘efficient’ a lot. What do you mean by efficiency in relation to investing?

The simple way of looking at this would be by analysing your costs, such as the taxes and charges within your portfolio. Academic literature has shown that you are more likely to underperform your benchmark by whatever your costs are. So it makes sense to reduce costs as much as possible.

It also means looking at what types of frictional costs you have. These are: transaction costs, fund manager costs, paying your broker as well as tax costs. Is it really worth the tax penalty that you might have to pay to make this investment? This means using your risk budget appropriately, something that clients tend to not think about very often. One way to invest might be to invest all your money into the shares of one company in the hope that they double, but that is essentially just gambling (and we do not recommend this). You need to invest with the highest probability of the highest return, after fees and after tax.

Why should clients focus on long-term gain rather than short-term profit?

It again comes back to risk. In the short term, the risks are heightened and investors can be very emotional, as you can see when the market falls quickly. Investors need to think about what the right thing to do in the long term is, what will enable you to achieve your goals, and to not just react to the fear of a bumpy market cycle. If you pull your money out when the market falls because you panic, you are only considering the near-term, and you will lose out on the potential gains you will make when the market inevitably rebounds. And the evidence suggests that markets do bounce back quickly. As long as you are properly diversified with a financial plan in place, you should focus on your long-term goals and not day-to-day market movements.

What is the difference between managing my investments and managing my wealth?

I think that the management of wealth considers understanding what our clients’ financial objectives and goals are and over what time period. It could be providing a private education or helping children pay for a house, or it could be philanthropy, whether actively giving or planning to leave a legacy. Managing wealth would consider how to incorporate a large restricted stock holding into a wider asset allocation for client working at a senior level in a technology company, or discussing how to treat a portfolio of rental properties producing a fixed-income like yield for a family with extensive property holdings.

Managing investments, however, is about understanding how collective investments are constructed, their appropriateness based on where clients’ are resident or how much tax they pay, ensuring they remain fit for purpose and, put simply, do what they say they are going to do and how they fit into a wider portfolio asset allocation. These considerations are a necessary precursor to actually implementing the research we’ve produced that determines where to optimally invest the money.