Portfolio construction is a mix of art and science. Abundant academic research identifies elements of the global securities marketplace that have presented opportunities for higher expected returns, or premiums, over time.
To capture these return premiums, we work to invest in a diversified, low-turnover manner through market cycles. Market leadership for various types of stocks and bonds will rotate and any particular strategy will not be in favor over all time periods. This makes diversification by both asset class (stocks, bonds and cash) and by location (U.S., developed international countries and emerging markets) critical.
Our preferred portfolio construction assumes the investment mix is being built from cash. However, occasionally clients ask us to build around some existing holdings that they prefer to keep. All portfolios are constructed in the context of a signed Investment Policy Statement (IPS). The IPS defines investment objective, target weights for various types of assets held and how we will measure performance.
IMPLEMENTATION OF INVESTMENT APPROACH*
- Determine the level of risk and expected return desired to align with financial goals.
- Select overall asset allocation that is best fit.
- Present this asset allocation to the client and obtain signed Investment Policy Statement.
- With approximately 30% of the portfolio, buy market-cap weighted index exchange-traded funds that provide the broadest possible diversification at the lowest cost. Using funds with low, or no, transaction fees allows these investments to be the primary tools for rebalancing and cash flow events that may be required. These funds would broadly cover U.S. stocks, international stocks and U.S. bonds.
- With roughly 60% of the portfolio, implement investments that utilize tilts toward the market premiums that we expect to add value over time. This portion of the portfolio will most likely feature investments from Dimensional Fund Advisors (DFA). We believe Dimensional offers a deeper level of academic rigor and evidence-based investment strategies than any other investment firm.
- The remaining 10% of assets may include individual stocks, cash, or specific satellite funds that have an objective specific to a client or an opportunity identified to enhance the risk/return of the portfolio.
- U.S. stock allocations will emphasize small, value-oriented and high-profitability companies. International funds will cover both developed and emerging markets with similar tilts toward market premiums as U.S. stocks. A moderate home country bias is included in the base-model scenario. The stock portion of an overall allocation is likely to be split approximately 60% to U.S. stocks and 40% to international stocks. For a 60% stock portfolio, this would be 36% U.S. stocks, 24% international stocks.
- Allocations to bonds will tilt toward higher quality and shorter duration issues compared to representative indexes for U.S. core bonds, high-yield bonds and foreign bonds. The intent of the bond portion of the portfolio is to dampen risk during stock market downturns and generate income that can be expected to offset inflation.
- Real estate investment trusts are allocated separately from stocks or bonds due to their dual nature of capital appreciation and income.
*This is a general description of how we build portfolios. Any individual client could have variations in their portfolio.