How Do You Manage Assets?
We know that indexing is the ideal way to allocate assets in a diversified, low fee and tax efficient manner. However, when we were constructing our own personal portfolios we always felt uneasy with the idea of a static “passive” portfolio like a 60/40 stock/bond allocation. We felt uncomfortable allocating our personal assets in this type of approach due to multiple deficiencies:
- The 40% bond portion is likely to generate very low returns in the future given the low interest rate environment.
- The 60% stock portion is likely to generate more of the volatility in the total return of a 60/40 and will therefore increase our risk to permanent loss at points during the market cycle. This will be particularly true later in the market cycle when stocks tend to become more risky and events like 2008 and 2002 occur.
- Our risk profiles and the financial markets are dynamic, however, a static portfolio doesn’t accurately reflect this reality of our financial lives.
We felt that these flaws could be resolved through tweaking the standard static passive portfolio to create greater parity between our risk profiles and that of the underlying markets over the course of the cycle. We achieve this by implementing a Countercyclical Indexing™ strategy. This strategy is based on 5 crucial elements:
1. Your portfolio is not actually an “investment portfolio”, it’s a “savings portfolio”. We focus intensely on understanding the financial world for what it is and not what we want it to be. This means understanding the financial world at an operational level. Our unique understanding of the monetary system helped us develop the concept of the “Total Portfolio” which focuses on thinking of your portfolio as a “savings portfolio” instead of the high risk and sexy “get rich quick” or “beat the market” concept that is often touted on Wall Street. This unique approach allows us to construct a portfolio management process that aligns the way clients perceive risk with the way their portfolios are ultimately constructed resulting in portfolios that seek to outpace inflation, reduce downside exposure and create a more predictable and stable savings portfolio.
2. Countercyclical Indexing™ can resolve many issues in a static passive indexing strategy. Traditional portfolio theory says we should rebalance back to a static or fixed asset allocation. We believe this is flawed as relative asset class risks are dynamic. For instance, a 60/40 stock/bond portfolio is much riskier late in the business cycle than it is early in the business cycle because the primary driver of returns (the 60% stock portion) will tend to become riskier as the business cycle unfolds. Therefore, we rebalance client portfolios on a cyclical basis to account for changing relative asset class risk. This adaptive approach helps us keep the risk profiles of our clients better aligned with our portfolio management style as the business cycle evolves.
- See our research paper on Countercyclical Indexing™.
- See our various strategies for more specific information on the approaches.
3. Our process is based on a “top down” global macro approach. We’ve leveraged our vast understanding of the financial system and the global monetary system to create portfolios that reflect the growing macro nature of the global economy. This means that we look at big trends from a 30,000 foot perspective in order to establish probable outcomes. We use our sophisticated understanding of the macroeconomic system as well as the capital structure to implement customized portfolios that help clients better achieve their financial goals.
- See also, Understanding the Modern Monetary System.
4. All of our portfolios are very low fee, tax efficient and systematic. Our broad asset allocation approach allows us to maintain a very low fee structure. Although we rebalance on a cyclical basis to account for relative asset class risk, we can do this without creating excessive tax inefficiencies, charging high fees or creating other portfolio frictions that degrade performance. Our average portfolio costs 0.17%-0.42% including all of the underlying expense ratios. Most importantly we avoid many of the most destructive behavioral biases in portfolio management by maintaining a systematic approach.
5. We use diversified ETFs and index funds exclusively. Diversification is crucial to any well balanced portfolio. We don’t know exactly what the financial markets will do over time, but we can substantially improve our odds of financial success by spreading our assets out over many different types of instruments. This is best achieved by using low fee ETFs. This allows us to keep our fees very low while maintaining diverse and efficient portfolios.