Mentor Financial Services constructs investment portfolios based on the theories behind the 'Capital Asset Pricing Model', which was a further development of Harry Markowitz's 'Modern Portfolio Theory'. Modern Portfolio Theory revolutionised portfolio theory in the 1950's when Markowitz proposed that investors focus on selecting portfolios based on their overall risk-reward characteristics. Prior to this, investors merely compiled portfolios from shares that may individually have had attractive risk-reward characteristics, but there was no regard placed on their effects to the overall portfolio.
The risk to any portfolio consists of systematic risk and unsystematic risk. Systematic risk is basically market risk, which is common to all shares on the ASX, and as such diversification will not reduce this risk because the entire share market is exposed to it. Unsystematic risk relates to risk that can be reduced through diversification as it is unique to an individual asset or asset class. It represents the component of an asset's return which is uncorrelated with general market moves. It is therefore logical to focus on reducing unsystematic risk by including a greater number of assets in a portfolio.
The Capital Asset Pricing Model assumes that the risk-return profile of a portfolio can be optimized by having the lowest possible level of risk for its level of return. Additionally, since each additional asset introduced into a portfolio further diversifies the portfolio, the optimal portfolio must comprise every asset.
One implication of this model is that a single mix of risky assets fits in every investor's portfolio. Those who want a high return hold a portfolio heavily weighted with the risky asset; those who want a low return hold a portfolio heavily weighted with a riskless asset.
Mentor has developed an optimal portfolio of growth assets and then, dependent on each client's attitude towards risk, we tailor the portfolio by reducing the risks inherent in growth assets by adding cash and fixed interest. For some clients Mentor increases the growth potential, and also risk, by using borrowed funds whilst having no exposure to cash.
Mentor believes that a portfolio of managed funds offers far greater diversification, and therefore less unsystematic risk, then a limited holding of direct shares; however we do provide advice on both.