Strategic Asset Allocation
We believe strongly in the time-tested investment strategy of Strategic Asset Allocation. Asset allocation is the process of constructing a diversified portfolio from a wide range of different asset classes. An asset class is a broad group of similar securities such as corporate bonds, large company stocks, or foreign company stocks as opposed to a single stock or bond. Examples of other asset classes would include high yield bonds, small company stocks, U.S. Treasury bills, and real estate.
We believe the most important type of asset allocation is strategic asset allocation. This involves setting a long-term investment policy, establishing weightings for various asset classes, and making few changes over the short run unless there is a specific change in the investor's objectives. We reject the strategy of "market timing," as it attempts to predict and capitalize on short-term market swings by shifting the portfolio into specific, concentrated asset classes (particularly stocks) at certain times to improve returns. A key reason why market timers have had so little success over the long-term is the nature of stock market results: much of the appreciation comes in brief, unexpected bursts that catch investors off guard.
Although outguessing the overall movement of stock prices is an appealing and enticing concept, it has proven very difficult to do consistently in practice. It may seem simple to wait for a market downturn and then intuitively buy stocks after they start going back up; but distinguishing between a brief rally and a major turning point is often an exercise in frustration. The financial media are fond of highlighting the next supposed hot stock or asset class, but attempts to pick the best stocks or just the right time to invest are surprisingly unproductive.
With few exceptions, strategic asset allocation policy determines how well investors fare over time. Although no investment policy can guarantee success, strategic asset allocation may help enhance portfolio returns by reducing volatility.
Proper strategic asset allocation may also reduce risk. Academic research has demonstrated that the performance of different asset classes is not always closely related; some do quite well at the same time others are declining. Asset allocation strategies take advantage of this lack of correlation to build portfolios that are unlikely to have assets that all do well or poorly at the same time. As a result, a well-diversified investment account is less likely to suffer huge losses in an unfavorable market environment.
* Strategic Asset Allocation does not insure a profit or protect against loss.
Dynamic Asset Allocation
Over the past 25 years, we’ve witnessed two of the worst bear markets since the Great Depression. From peak to trough, the S&P 500 index lost over 50% of its value from 2000-2002 (often referred to as the “tech bubble”) and again just 5 years later from 2007-2009 (often referred to as the “Great Recession”). Regardless of the causes and the name tags, the reality is that even the best strategic asset allocations suffered significant losses because historically diversified correlations among so many asset classes moved closer to one during these extended major bear markets. This trend has continued during subsequent, albeit less severe and protracted market corrections (including COVID in 2020 and rising interest rates in 2022).
The resulting conclusion from the two historic 50%+ market downturns was that diversification failed to work as good in practice as it did in theory… and at the worst possible time. Because of that, Modern Portfolio Theory (MPT) and its core component strategies, asset allocation and rebalancing – indeed, any investment strategy not involving cash in a mattress – came under attack. Long-term investment professionals like ourselves were even found asking: are we missing something? Our conclusion: even the best-designed MPT/asset allocation/rebalancing system is not infallible, which presents significantly enhanced risk to clients near or already in their retirement years.
From these experiences, combined with several decades of in-depth market study and research, we have determined that a second important type of asset allocation is essential for our portfolios: dynamic asset allocation; and we have added that into our models alongside our fundamental and foundational strategic asset allocation approach. Whereas strategic asset allocation continues its proactive approach by establishing long-term weightings of asset class allocations and staying fully invested through market ups and downs, dynamic asset allocation seeks to be more reactive to significant market movements, specifically attempting first and foremost to provide greater downside protection during protracted market declines. This strategy aims to take advantage of market momentum that historically tends to overshoot “rational” investor behaviors by reacting in a disciplined quantitative/tactical buy/sell approach to the resulting “mean reversion” when such excesses turn market momentum in the opposite direction.
To be clear, we continue to disavow “market timing” as a reliable investment strategy. We believe our use of dynamic asset allocation – while quantitatively and tactically making trades on market momentum in a predetermined, disciplined process – is not the same as market timing. Market timing purports to replace a disciplined financial/economic theoretical framework with gut instinct and intuition. Unlike market timing, dynamic asset allocation is not a ‘get-rich-quick’ or ‘beat-the-market’ scheme. Instead, it is a fundamentally sound, fully realized, ‘not-get-poor-quick,’ risk management approach. It is an advancement of sound stewardship of client assets, consistent with our fiduciary duty to our clients. In short, our dynamic asset allocation strategies are designed to help when strategic strategies are most vulnerable – during periods of significant and protracted market declines.
With today’s globally integrated economies, complex markets, and the experimental monetary and fiscal policies being used by governments and central banks alike, we believe the unique combination of dynamic asset allocation and strategic asset allocation represents the next generation of innovative investment risk management.
* Dynamic Asset Allocation does not insure a profit or protect against loss. Enhanced market volatility poses specific potential risks to dynamic asset allocation strategies as large market swings can create “whipsaws” that cause unprofitable trades and can create a drag on performance versus a buy and hold strategy. Moreover, dynamic asset allocation can be inefficient on an after-tax basis due to the potential recognition of short-term capital gains resulting from excessive volatility triggering sell trades that are not managed for tax-efficient outcomes.
Defining Risk
Everyone talks about risk in connection with investing, but few understand how to actually define it or to measure it. An investor may know intuitively that “safe” investments like insured bank CDs or Treasury bills have “low” risk, or that stocks have “high” risk, but these are vague terms. Higher or lower than what? And by how much? And how dies one calculate the risk for a whole portfolio containing different types of investments? We believe a more precise method of describing and assessing risk is a statistical measure known as “standard deviation,” expressed as a single number showing how results in a given period vary from a long-term average.
Investors inherently don't like risk; and insist on getting compensated for it. Investments that are the most unpredictable (the highest standard deviation) also have the potential to generate the most attractive returns over a long period of time. These would include aggressive growth stocks and foreign issues, for example. Investments with low risk (Treasury bills, bonds, etc.) produce lower returns, but usually with much greater predictability.
The purpose of strategic asset allocation is to quantify the risk associated with various asset classes as precisely as possible and construct a portfolio offering the best possible blend of investments to suit your overall objective and risk tolerance. The role of dynamic asset allocation is to mitigate significant negative returns when markets move past their historical standard deviation measures.
There is no such thing as a single “best” asset allocation policy since investors have a wide range of objectives. The key, therefore, to assembling the appropriate portfolio for you revolves around a thoughtful and thorough discussion with our professional investment advisors of your financial goals, cash needs, investment experience, and tolerance for fluctuations in portfolio value.
* Taking on more risk does not ensure a higher return. Past performance is no guarantee of future results.
Securities Selection
We believe that mutual funds and separately managed accounts (SMAs) represent the best method of active investing for most investors. Mutual funds are a pooled collection of assets that invests in stocks, bonds, and other securities, managed by a lead portfolio manager(s) and accompanied by a team of analysts. Each investor in a mutual fund owns a share(s) of that fund representing a small portion of all the investments inside that mutual fund. Mutual funds do not trade intraday like individual stocks and bonds. Instead, they are valued each day after the markets close. A Separately Managed Account (SMA) is a type of investment portfolio owned by an individual investor but managed by a professional investment manager. Unlike mutual funds or ETFs, where multiple investors pool their money together, an SMA is customized specifically for a single client’s needs, allowing for a tailored investment strategy. An SMA’s portfolio can also be traded and valued intraday through the pricing and/or buying and selling of its underlying holdings, providing more opportunities for tax-efficient investing.
We do not proclaim to be "stock pickers,” but instead realize our true role as investment allocation specialists, financial advisors, and wealth managers. The institutional money manager has a resource and knowledge edge for stock/bond selection and management that is significantly beyond what anyone in the [financial planning or wealth management] business can bring to the table. Put a different way, it is inconceivable that someone who does something other than focusing on stock/bond selection (which includes wealth managers, most stock brokers, and certainly clients) and has far less resources than the professionals they are competing with, can look at a stock or bond and presumably determine an inherent value; then, determine that, if that stock/bond is bought, the market value is less than the inherent value and constantly re-evaluate that. In short, the "amateur" is not going to beat the professionals over the long run. This has been proven time and again through multiple studies.
Therefore, we spend our time and energy identifying mutual fund and SMA managers that have provided consistently strong performance year after year relative to a meaningful peer group and benchmark. Because of the financial media's focus on each year's hottest performers, many investors never hear about the funds and managers that provide this kind of consistent performance. Our research of mutual funds and SMA managers is conducted using an extremely thorough and analytical analysis of a number of important factors. Investing excellence means more than last year's return – or even the last ten year's records. It must take into account a much wider range of factors, including fund management experience, performance consistency, expense costs, and portfolio management discipline. Managers who have a clear philosophy and consistently implement it through a disciplined process are more likely to be able to replicate the results. If we change our opinion on a mutual fund or SMA, it’s usually because of a fundamental change in the fund/SMA or its management, not simply due to a shift in short-term performance.
A short period of under-performance doesn’t always indicate the mutual fund or SMA manager has lost his or her touch. It may, in fact, simply demonstrate that the manager remains true to their objective and style regardless of short-term changes to market trends and emphases. However, we do carefully watch and monitor the managers we select for several types of events – in conjunction with poor performance – that will merit an in-depth review of a manager and potentially lead to a change. These primarily include:
- Change in management company ownership,
- New portfolio manager or team,
- Significant change in asset allocation,
- Substantial drift in investment style, and/or
- Sustained under-performance against benchmarks and/or peers.
This comprehensive process illustrates our hands-on, active approach to active manager selection, which our empirical data suggests has had a positive impact on the long-term consistency of our clients’ investment portfolio performance. Keep in mind, however, past performance is no guarantee of future results.
In addition to active mutual fund and SMA managers, we also use Exchange Traded Funds (ETFs). ETFs are typically passive “index” investments that allow intraday trading just like individual stocks and bonds. More recently, however, we’re beginning to use active ETFs that many mutual fund companies are offering to provide the same [or mirrored] investment management of an actively managed mutual fund, but at a significantly lower cost. The ETFs we use most are passive investments, in that they don’t have investment managers, but instead simply track a specified market index. Our goal with ETFs is to gain broad market exposure to indices with the most liquidity and lowest cost possible. We use ETFs and the “passive” index investment strategy exclusively in our dynamic asset allocations.
Model Portfolios
As we do with almost every aspect of our business, we have from time to time cast a critical eye upon our investment strategies. While we are happy with our current investment approach and its seamless fit into our wealth management practice, we are always looking for ways to improve and refine the investment services, products and strategies we provide to our clients.
We arrived at our current investment approach through an evolutionary process that continues today. We have created and modeled broad asset allocations that are used as a starting point for investing client portfolios. Currently, we use seven model portfolios, each composed with a combination of actively managed mutual funds and/or SMAs (as described above) and index-linked exchange traded funds (ETFs). These portfolios range from balanced/conservative to aggressive growth with varying levels of tax efficiencies. Although ETFs, mutual funds, and SMAs may lose value, we believe that their breadth of diversification enhances the long-term success of our clients’ portfolios in both up and down markets.
While these models serve as base portfolios, each client account is unique because of inception date, cash flow needs, tax implications, fund manager selections, and specific client preferences. Lower-expense portfolios are also one of our key strategic goals. Keeping an overall cost to you, our client (e.g., our fee, platform fees, and the fees of the underlying investments) below that of the average investment advisory platform is paramount for long-term success and ultimate client satisfaction.
Through the use of ETFs for “core” positions inside the portfolios, the overall expense ratios of our portfolios can be lowered while providing exposure to a wide set of asset classes that are needed in order to achieve good risk-adjusted returns. As alluded to above, we also use actively managed mutual funds and ETFs run by managers who have been identified as being capable of adding value in their respective asset classes and/or sectors. These “enhanced” portions of the portfolios provide the potential for positive performance during unfavorable market trends and more reasonably managed risk during market “bubbles”.
The specific allocation levels at which we incorporate ETFs versus actively managed mutual funds and/or SMAs varies depending on existing market and economic conditions as well as the overall weightings between Strategic Asset Allocation and Dynamic Asset Allocation. Core positions may be set using either, or a combination of both. For high net worth (HNW) clients, our portfolios typically use SMAs and ETFs more extensively for better tax-efficiency, greater customization, and the ability to reduce fees even further through more significant platform fee breakpoints.
Alternative Investments & Annuities
Two additional methods of investing that we may implement in and alongside our model portfolios is alternative investments and annuities. Alternative investments and strategies vary a great deal across a broad spectrum of alternatives including hedge strategies, real estate, private equity, private credit, commodities, structured products, master limited partnerships (MLPs), and business development companies (BDCs). Various mixtures of these investments are strategically used in our model portfolios with the intent of capturing positive returns while reducing overall portfolio volatility and losses due to their low correlation to other traditional portfolio allocations. In this area, we actively utilize our unique access to some of the most prominent alternative investment companies and institutional managers available in the world.
Annuities often get a bad rap from financial media personalities. However, these unique financial products have their purposes and can be used extremely efficiently to address many investors’ desires for wealth accumulation, guaranteed income protection, and tax deferral. There are also many different types of annuities that each have unique features and purposes. For investors seeking to ensure a reliable income stream during retirement, annuities offer benefits such as predictability, tax advantages, and options for customizing to fit specific needs and goals. Navigating the world of annuities can be complex, and the right choice depends on your personal financial situation and retirement goals. Our process of annuity selection and use begins and ends with your needs and goals.
It's also important to note that our process of being a fiduciary and acting solely in your best interest is never compromised, regardless of the type of alternative investment and/or annuity that may be implemented to help achieve your long-term goals. We spend extra time and effort going through the intricacies and details of all these type of investment products so you can have the confidence and knowledge of the costs, risks, and special features.
* Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes, and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
Client Portfolio Strategy Reviews
Our model client portfolios have behaved in a consistent fashion. All performance-based communication with our clients is consistent, educational, and fact-based rather than promised-based. We explain to all our clients and prospective clients that our goal is to achieve risk-adjusted market returns in their portfolios consistent with their unique goals and resources. The specific risk/return characteristics of each client’s portfolio are tied to the all-important selection of their strategic asset allocations.
That decision, made jointly between you and your primary advisor, is based upon risk preferences and wealth management outcomes. At each review meeting, we provide reports that include net-of-fee returns and then compare those returns to a wide variety of appropriate and relative market indexes and benchmarks. Setting reasonable investment expectations is paramount. The quality of these discussions can then be greatly improved as we spend more time on elements of your financial life that you can control, or at least affect, and less time discussing performance from a perspective of hindsight biases and arbitrary measurements.
Our review and strategy meetings with you are dynamic and ongoing. We continually use our reviews to reinforce and educate our clients to our investment approaches, clarifying the fundamental tenets and standards on which our investment advice is based. We also regularly clarify the following things that do not impact our advice, but which are so often touted by so-called “financial experts” in the media and wirehouse firms: (1) we will never promise to consistently outperform or “outfox” the markets; (2) we won’t make portfolio changes based on the latest political or economic events in the news; and (3) we’ll never chase returns of hot sectors and/or stock tips from relatives, golf partners, or zany cable TV money show hosts.
As stated above, we are not stock-pickers or market-timers. And that is not how we attempt to add value to our clients' lives. Instead, we stay focused on accumulating and preserving your wealth that is consistent with your goals, personal investment profiles and preferences, and overall financial resources.
In Review
We understand that not all investors are attracted to our investment philosophies and strategies – a fact of life that we are willing to live with. We employ great discipline of adhering to tried, tested, and proven fundamental investment principles – an approach that we are committed to, which is consistent with our disciplined approach to investing and wealth management. And while we’re confident that this approach is providing an excellent value to our clients, we will never stop researching for better ways to do things. We will continuously evaluate changes that provide an opportunity to efficiently provide our clients more and better services, investment strategies, and financial products that improve their lives and fulfill their dreams. That is our commitment.
