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| Our Investment Advisory Services |
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The Harder You Look, The Better We Look
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| Our Investment Perspective |
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Richard Shaw, Principal
Effective portfolio management pursues investment return with controlled risk, taking into consideration investor goals, resources, obligations and limits.
Investing is a constant trade-off between return and risk. Asset class choices and mixtures are the fundamental keys to that trade-off. Individual security selection makes only a secondary contribution to results.
Studies show that roughly 90% of returns are determined by the asset allocation decision, and only about 10% by security selection and market timing. That’s why we spend most of our time working on asset class choices and class allocation weights for our clients.
Risk Control Is Critical: Uncontrolled high risk investment behavior is the domain of youth who have the time and opportunity to learn from mistakes, to use future earnings to replace losses and to try again. Managed risk behavior is the domain of mature investors dealing with much larger amounts and who do not have the time, opportunity and future earnings to replace lost assets.
Risk control is possibly the most important part of a long-term wealth building or wealth conserving program. Losses are difficult to recoup.
Expense Control: Most investors utilize funds to one degree or the other. Some use only funds. Selecting funds with low expense ratios can make a significant contribution to overall results over time. Expense ratio differences may not seem important in strong market years, but in the long run fund expense ratios are an important factor in total return.
Quantitative Element of the Approach: Modern portfolio management practice combines quantitative techniques enhanced by computers and governed by common sense, judgment, fundamental information, and investment wisdom. The computer modeling approach relies significantly on Monte Carlo simulation and mean variance optimization. Monte Carlo simulation runs thousands of scenarios to explore the range of possible outcomes. Mean variance optimization finds the best allocation of multiple asset classes in a portfolio for any target return or risk level. The process is based on three key criteria: (1) mean return, (2) variation of return, (3) correlation of return between the asset classes.
Qualitative Element of the Approach: Computers alone can’t pull the wagon and historical data cannot be relied upon without human interpretation within the current and expected future context. Human judgment about expected returns, variance and correlation is a necessary component to portfolio design and management.
Reversion to the Mean: Also at the heart of asset allocation is the principle of “reversion to the mean” -- that is to say that returns for each asset class tend to revolve around some average. Above average returns tend to move down to the historical average over time, and below average returns over time tend to move up to the historical average. Mean reversion is one of the most powerful forces at work in markets. Like gravity which inevitably pulls us back to earth, mean reversion pulls returns toward long-term averages.
Rebalancing - Harvesting and Reinvesting: As the asset class returns in the portfolio vary, periodic rebalancing harvests profits from those assets with relative strength and reinvests in those assets with relative weakness. This is a value orientation and is mildly contrarian in approach, because it involves scaling out of popular asset classes as they rise and scaling into comparatively unpopular assets as they decline. Rebalancing honors the time proven principle of “sell high and buy low”, unlike those who chase yesterday’s hot investments who are buying high hoping to sell even higher. Buying low and selling high as a method has a lower risk of loss than buying high and selling higher.
Rebalancing - Risk Management: Different asset class have different levels of risk (volatility). As the asset class weights in a portfolio change due to differences in return, the composite risk (volatility) of the portfolio changes. Since the portfolio was designed to fall within a certain risk as well as return range, rebalancing is a way to restore the risk expectations as well as the return expectations of the portfolio.
Emotional Element of the Approach: Asset allocation is not compatible with speculation, tip-sheets or chasing momentum -- all of which appeal to the human desire for short-term results. Speculation requires continual back-to-back short-term wins which are elusive. Unlike speculation, asset allocation can seem boring, because it is like being the hare in the rabbit and hare race fable -- the hare wins in the end.
With asset allocation, the portfolio will never be the highest rate of return in any given year, but will be a solid relative performer. However, over the long-term, the well allocated and rebalanced portfolio will be among the highest cumulative return investment approaches.
It takes guts to stick with asset allocation in the face of seemingly great short term opportunities or temporary market setbacks.
Creating wealth through a series of short-term investments is more difficult and more risky than taking a long-term approach through asset allocation and rebalancing.
Any and all investment approaches have good periods and poor periods of performance. It is human nature to abandon whatever approach is being used in the face of declining fortunes to seek another way. However, history has shown that asset allocation is the best approach. To make asset allocation work, the investor must stick with it and not enter, exit and re-enter the process, based on short-term ups and downs.
Institutional Approach: Asset allocation is the method used by the largest pension and endowment funds in the world, yet its tenets lean against the wind of crowd opinion and behavior. That is an emotionally difficult posture to maintain in the face of the noise and excitement or depression of media headlines and chatter among associates.
Advisor Role: Your investment advisor must help you understand your overall needs and risk limits, design an appropriate portfolio and provide continuing guidance or management for that portfolio, but also lend you strength to stay on your chosen path when conviction falters in the face of short-term conditions, headlines and media talking heads..
Contact Us: We would like to show you how our asset allocation services can help you.