Investment Philosophy

Investment Philosophy

Our investment philosophy is based on the application of objective research to fundamental and rational investment methodologies and incorporates the dominant theories that guide the handling of trillions of dollars of institutional investments. Clients are encouraged to realize the benefits of ownership offered by equities, whenever appropriate. An abundance of historical evidence supports the conclusion that equities are the financial asset of choice for investors seeking to fund long-term goals. This is consistent with modern economic theory, which tells us that the equilibrium condition of a durable free capital economy requires that equity investment returns, in total and over time, must exceed those of fixed-income investments. We do not pursue trading strategies or believe that it is possible to time the market. Instead, we believe that the optimal accumulation of financial wealth for our clients can be realized by incorporating the objective research into capital market behavior that has been performed by leading academic sources and centers for financial economic research, including:

  • Exposing the portfolio to factor premiums that produce higher rates of return
  • Controlling risk through global diversification and the application of Modern Portfolio Theory
  • Utilizing institutional investment products and cost structures
  • Minimizing taxes whenever appropriate

Our firm chooses to rely upon academic research into capital market behavior conducted by leading centers for financial economic research and subjected to rigorous peer review. It is our firm belief that this body of research should form the basis for our investment philosophy. Key to the understanding of the dominant academic views is market efficiency – that securities prices at any time reflect all available information. Higher expected returns can be achieved by exposing capital to risk premia that have proven to be persistent and pervasive across markets. The expected return for equity investments is determined by multiple factors:

  • Exposure to market risk, thus stocks have a higher expected return than fixed income.
  • Size, thus small company stocks have a higher expected return than large company stocks.
  • Value, thus stocks that exhibit a low market price in comparison to the company’s underlying assets (a high book-to-market ratio) have a higher expected return than stocks with a low book-to-market ratio.
  • Momentum, thus stocks that are rising in price tend to continue to do so for a period of time.
  • Profitability, thus profitable companies of today tend to be more profitable in the future.

In the realm of fixed income, two factors drive returns – maturity and default risk. Fixed income securities are interest sensitive investments without substantially stronger long-term expected return. Thus, the role of fixed income exposure in portfolio construction is that of lowering portfolio risk in order to dampen the volatility of equity investments, allowing portfolios to be constructed with risk/return characteristics that are appropriate for the individual client’s risk tolerance and time horizon. Our core fixed income strategies use a "variable maturity" approach to high-grade corporate and government debt that involves no interest rate forecasting. The strategy shifts the maturity structure in response to changes in the current yield curve by identifying the points on the curve offering the highest expected return per unit of volatility. Global strategies are diversified across developed international markets and hedge currency exchange rate risk.

Modern portfolio theory (MPT) was introduced by Harry Markowitz with his paper "Portfolio Selection," which appeared in the 1952 Journal of Finance. Thirty-eight years later, he shared a Nobel Prize with Merton Miller and William Sharpe for what has become a broad theory for portfolio selection. Detailing the mathematics of diversification, he proposed that investors focus on selecting portfolios based on their overall risk-reward characteristics instead of merely compiling portfolios from securities that each individually have attractive risk-reward characteristics. In a nutshell, investors should select portfolios, not individual securities. Out of the entire universe of possible portfolios, certain ones will optimally balance risk and reward. These comprise what Markowitz called an efficient frontier of portfolios. An investor should select a portfolio that lies on the efficient frontier. Sharpe (1964) formalized the capital asset pricing model (CAPM). CAPM introduced beta and relates an asset's expected return to its beta. Further research conducted by Fama and French, Carhart, Novy-Marx and others led to the development of modern multifactor pricing models that are capable of explaining the vast majority of diversified equity portfolio performance over significant time periods.

The cost structure of retail investment products creates significant drag on investment performance. Institutional investors demand, and receive, highly competitive cost structures that are a fraction of what is paid by typical individual investors for retail products. By making institutional products available to our clients as components of carefully designed and managed portfolios, we allow them to take advantage of favorable cost structures that enhance portfolio performance. Conversely, by managing client expectations and educating clients regarding strategic asset allocation, we protect institutional fund managers from reactive client behavior and unpredictable cash flows that can create additional expense that would be unacceptable to the fund manager’s institutional client base.

Recognizing that some clients are tax-sensitive, we incorporate tax-managed strategies when appropriate. The tax-managed strategies deliver the same consistent exposure to factor premiums with an emphasis on maximizing after-tax returns. Many clients hold portfolios of both taxable and retirement accounts. When developing portfolios for these clients, emphasis is generally placed on efficient asset location - the allocation of the least tax efficient asset classes to retirement accounts in order to minimize current tax impact.

Thoughtful investment policy targets, carefully implemented and steadfastly maintained, create the foundation for investment success.  To learn more about our approach to investing, read "From Financial Economic Theory to Real World Portfolios", found here.

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