Modern Portfolio Theory is used as the basic construct for defining portfolio allocation for our clients. There are adjustments to weightings over time as modified by individual client characteristics and conclusions derived from the application of the Adaptive Markets Hypothesis, fundamental analysis, and market cycle analysis. The final result is a more dynamic approach to asset allocation by utilizing larger long term strategic allocation range thresholds and increased frequency of tactical allocation shifts.
Generally, rebalances to bring the portfolio within target allocation thresholds should be semi-annual, but can opportunistically be more or less if deemed appropriate.
Behavioral Finance and the Adaptive Markets Hypothesis:
The goal of practical application of AMH is to reduce risk taken for a given level of target return over the long run by accounting for market and individual investor biases and altering target allocations throughout the market cycle in response to changing risk premia. The effect of application of this philosophy will be:
- Widen strategic allocation ranges for each risk level
- Utilizing more frequent tactical allocation shifts
- Dampen the unavoidable psychological stress that results from participating in publicly traded markets by responding to market cycle dynamics and changing risk premia
Fundamental Analysis:
Fundamental analysis will be utilized by screening for various quantitative and qualitative factors in identifying new investment opportunities. Some factors that will be screened for are those nine designated by “Fundamental Analysis, Future Earnings, and Stock Prices” to have a statistically significant predictive value for future earnings (Abarbanell & and Bushee, 1997). Additionally, other ratios and personally-constructed factors may be used to screen for investment opportunities (e.g. years to debt payoff from FCF). Once a list of potential investments is identified the list may be further narrowed by investigating qualitative factors like investor sentiment, core brand strength, market vision by leadership; reviewing various analyses from other market participants; and accounting for unique investment requirements like theme targeting, dividend preferences, and market capitalization.
Market Cycle Analysis:
The Conference Board publishes leading, coincident, and lagging indexes designed to signal peaks and troughs in the business cycle for major economies around the world. These indexes along with information gleaned from other research will aid in forming recommendations for tactical broad allocation shifts based on where we are in the business cycle. There may also be sector allocation shifts based on institutional, personal, and/or peer-reviewed research to exploit cyclical patterns of sector performance.
