Our strategy is to create a well-diversified portfolio of equities, fixed income, and alternative investments to both preserve and grow long-term capital for our clients. We accomplish this by using no-load actively managed mutual funds and passive exchange traded funds (ETFs) that span both the geographic and capitalization spectrums. Our typical equity portfolio consists of between 10-15% in small cap funds, 10-20% in international funds, 5-10% in “alternative equity” strategies (sector funds, emerging markets, etc.), and the remainder of the equity allocation consists of domestic mid to large cap funds/ETFs. Many of our clients own individual stocks, which we typically do not recommend but will advise on the positions or opine on position sizes. Depending on the client’s risk tolerance, we recommend an allocation of 20-50% in fixed income strategies. Like our equity allocation, we aim to create a diversified bond portfolio that covers the major sectors of the fixed income universe. The goal of our fixed income sector is to act as a portfolio stabilizer during times of equity market volatility and to provide current income to clients. Depending on market conditions, we may shift these allocations, but we almost never go to zero, as we do not believe that doing so is in accordance with the “prudent man” rules.
Our proprietary fund screens have multiple factors that we compare when determining our investment choices. Some of these elements consist of top-quartile intermediate to long-term risk-adjusted return (measured primarily by Sharpe and Sortino ratios), longevity of management, and reasonable expenses. Expenses vary based on the type of investment, but we want all our managers to be in the bottom half of expenses for their sector. Our screens are all run in house, and they are key to achieving our goals of maximizing performance while limiting expenses. We do not run firm wide portfolio models, as it is our opinion that every client should have a portfolio that caters to their specific goals. We monitor our fund/ETF performance monthly, and produce reports for our clients twice yearly, at the calendar year end and again in July (6/30/XX). These reports show the full allocation of assets coupled with the past four calendar years of performance and with the three- and five-year average annualized returns.
While we have several basic criteria for analyzing our mutual funds and exchange traded funds, there are specific issues to consider when allocating between equity investment sectors (growth, value, small cap and international). Below we offer some ‘color’ on how we manage each of these different sectors and investment styles.
For our domestic growth allocation, our goal is to incorporate both active and passive strategies to cover all the major growth sectors. Our ‘modus operandi’ is to have a broad-based passively managed ETF as the ‘core’ allocation, with two to three actively managed funds that have high ‘active share,’ meaning they do not look like the underlying index. We eliminate actively managed funds that closely track their benchmark to avoid unnecessary higher expenses. As an example, if we were to have a client with three funds in the domestic growth sector, we would utilize one passive ETF, one active growth manager that has a focus on quality growth companies, and another that has a bias towards momentum stocks. Most of these strategies have some mid-cap exposure built in, but if the client has enough risk tolerance, we will often add a dedicated mid-cap manager. We have found that over time, we are able to offer market-like returns with slightly less volatility.
We tend to take a similar approach to domestic value equities as we do growth. We have a passive strategy at the core, bookended by multiple actively managed funds. Within these actively managed funds, we will typically hold one mid-cap manager, one focused quality-oriented fund, and another manager that incorporates a blend approach. Under most circumstances, we try to keep growth and value equities evenly allocated, as we do not believe that we can call short-term trends in these styles.
Small Cap Equities:
For small cap equities, we utilize ETFs less than we do in the domestic large/mid-cap growth and value sectors. Evidence shows us that it is easier for good active managers to add alpha in this sector, as there tends to be less analyst coverage for smaller companies. Our typical small cap allocation is between 10-15%. For those clients that have a higher small cap allocation, we will incorporate a passive ETF, but most of our small cap exposure is actively managed. Within the small cap allocation, we often employ a combination of growth, blend, and value strategies. As we do in large cap equities, those three investment strategies tend to be equally weighted.
We have a bias towards actively managed funds in international equities for the same reason as our small cap sector: less analyst coverage. We also try to even weight growth and value within international equities, but our broader focus is geographic diversification. Most clients will have exposure to major European and Asian markets. For those with a higher risk tolerance, we will add Emerging Markets and even small cap international equities. Our view is that even though international stocks have struggled for the past decade, long-term demographic trends along with mean reversion should continue to make most ex-US markets attractive places to invest.
Since we are a small team, we do not analyze and invest in individual bonds, rather we utilize mutual funds and ETFs as we do for equity investing. Our goals for a fixed income portfolio are capital protection and income with a focus on the former. In the current zero interest rate environment, income is hard to find, and we prefer not to add extra risk in search of yield. We use very similar screens to find our bond mutual funds as we do with equities. The goal is to have a broadly diversified portfolio encompassing all major sectors of the bond market (Government Securities, Asset-Backed, Mortgage-Backed, Municipal Bonds, High Yield, Corporates, Global, etc.). For most clients, we will also add an “unconstrained” strategy that hopes to identify pockets of opportunity across all fixed income sectors.
We use both TD Ameritrade and Fidelity for custody of our client assets. Both are reputable brokers, and neither are an investment bank, so they do not trade on their own accounts. We negotiate trading costs with each custodian, and both offer competitive market rates. We are buy and hold investors, so trading costs are typically nominal in any given year. Our aim is to hold most investments for at least a full business cycle (5-7 years) or more. It is our belief that the best way to help clients achieve their financial goals is to exercise both prudence and patience, and that a well-diversified portfolio along with the passage of time will produce the best outcome for our clients.