My firm’s investment policy focuses on using asset allocation and diversification as the primary means of achieving a client’s desired investment goals. I recognize the preponderance of academic evidence that the capital markets are highly efficient. Given this, I construct portfolios primarily using securities that are cost-efficient, diversified, and tax efficient. My strategy seeks to maximize after-tax risk-adjusted total return for the client.
Allocation, Allocation, Allocation
Several academic studies indicate that investment policy and asset allocation explain that from 90% to 100% of a portfolio’s return. Therefore, our policy focuses on the allocation of several asset classes as the determinant of investment results rather than individual security selection. Money market funds, fixed income, domestic equities, real estate, and international equities are all integral components of a suitably balanced portfolio.
Stay Indexed & Passive, Avoid Active
Index-based securities and funds are well suited for asset allocation since they are more style specific in terms market capitalization and sector exposure than most actively managed mutual funds which are prone to “style drift”. For example, a large cap value fund may buy growth stocks in order to improve performance. Regardless of the correctness fund manager’s judgment call, the risk and return profile of the fund can change substantially from the time the investor initially invested in the fund. Using indexed-based securities allows the investor to select the appropriate value/growth mix knowing that the underlying securities bought will be more stylistically consistent over the life of the investment.
Follow Academic Research
Based upon considerable academic evidence that value stocks and smaller capitalization stocks outperform over the long term, I seek to add value by judiciously increasing the value bias and smaller company bias in the weighting of the equity portfolio. The most relevant academic research has been done by Eugene Fama and Kenneth French of the University of Chicago. Fama received a Nobel prize in 2013 for his research.
I also seek to add value by including international equity investments, real estate investment trust and various alternative assets which offer broader capital market exposure and which have low correlations to the U.S. equity markets.