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Our Strategies

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Orcam Financial Group specializes in constructing diversified, low fee, tax efficient portfolios that match an investor’s risk profile with the cyclical changes in the markets as the business cycle evolves.

We call this approach “Countercyclical Indexing™” because it is a low fee, tax efficient and diversified strategy designed to match an investor’s profile to the changes in the business cycle as stocks tend to become riskier late in market cycles and less risky early in market cycles.

Rebalancing a portfolio over the course of the business cycle is part of any good portfolio plan.  But traditional portfolio theory says that we should rebalance a portfolio back to our initial nominal asset weightings.  For instance, a 60/40 stock/bond portfolio is cyclically adjusted at times to rebalance back to a 60/40 weighting as stocks tend to become overweighted relative to bonds due to outperformance.  But this linear or static portfolio allocation will expose investors to high levels of risk at the riskiest points in the business cycle because a 60/40 stock/bond portfolio is actually less risky early in the cycle and more risky late in the business cycle. In other words, traditional portfolio theory does not account for the dynamism of the business cycle which results in portfolios that do not properly account for changing risks during the course of the cycle. This leaves your risk profile misaligned with asset class exposure at various points in the business cycle.

This is due to the fact that, as assets rise relative to other assets, they become increasingly risky. Likewise, as certain assets decline in value they become less risky relative to other assets. This means most investors are overweight risk late in the business cycle and underweight risk early in the cycle.  We can quantify this empirically, for instance, because stocks have historically performed better in the first half of the business cycle than they have in the second half of the business cycle when accounting for relative risks and returns.¹  Despite this reality most investors chase returns late in the business cycle and sell early in the business cycle.  Not accounting for the dynamism of relative risks in asset classes means most investors underperform on a risk adjusted basis over the course of the cycle.

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Although our approach is relatively inactive (meaning we don’t make frequent changes to the portfolios on a quarterly or annual basis) we do tilt portfolios on a cyclical basis as relative risks evolve.  We rebalance to adjust for risk because we know that our clients have perceptions of risk that are just as dynamic as the financial markets.  Most investors tend to chase performance as assets increase in value.  But what they’re really chasing is not performance, but risk.  This is why so many investors tend to buy high and sell low.  Our approach is designed to counterbalance this response.  We adjust for risk as the cycle evolves thereby helping to keep our client’s risk tolerance in-line with that of the various asset classes we hold in underlying portfolios.

This approach is grounded in global macro understandings, but is also derived from two time tested approaches – Ray Dalio’s Risk Parity approach² and William Sharpe’s Adaptive Asset Allocation approach³.  However, unlike Dalio’s Risk Parity approach we don’t seek to create parity across risks in the portfolio.  Instead, we utilize an adaptive methodology similar to William Sharpe’s adaptive Asset Allocation style based on the understanding that market values and risks are dynamic.  Therefore, it is logical to rebalance portfolios over the course of the business cycle to account for these changing risks.  Although the investor’s risk profile is generally static over the course of the business cycle, the investor’s portfolio will actually change over the course of the business cycle and expose them to varying degrees of risk. Our Countercyclical Indexing™ strategy establishes a portfolio management approach that is more consistent with the way investors actually perceive risk over the course of the business cycle and increases the probability of improving risk adjusted returns.

Our global macro strategies reflect the personalized risk profiles of our clients. Depending on your specific profile you will own a version of three countercyclical indexing strategies. All of these strategies are low fee, tax efficient, broadly diversified index based approaches that are based on a systematic portfolio management approach.

 

Orcam Conservative Countercyclical

The Orcam Conservative Countercyclical strategy is a lower risk portfolio designed to generate low and stable returns.  The portfolio overweights protection against the risk of permanent loss relative to the risk of purchasing power. This portfolio invests in a diversified set of low fee global index funds in a tax efficient approach.

The Conservative Countercyclical portfolio is designed for the investor seeking income and safety who understands that bonds won’t generate sufficient returns in the coming decades and is therefore willing to take some equity market risk to offset this low return environment. On the other hand, this portfolio is also designed to minimize exposure to large drawdowns and the risk of permanent loss. This portfolio tends to be underweight the risk of purchasing power protection in favor of greater permanent loss protection while generating income and low but stable returns.

The strategy is a systematic allocation that takes the inverse of the current market capitalization of stocks relative to bonds and money market funds throughout the business cycle. Our research shows that this approach has generated good risk adjusted returns over the course of the market cycle due in large part to the behavioral errors of retail investors.  Historically, investors tend to become more aggressive as the business cycle expands and less aggressive as the business cycle contracts.  In other words, they tend to be overweight stocks at the riskiest points late in the business cycle and underweight stocks early in the business cycle when stocks are least risky. This is largely due to behavioral flaws in their response to the markets. The Conservative Countercyclical portfolio overcomes this flaw by applying a systematic passive approach to indexing that works to counter the market’s booms and bust phases.

Most importantly, this portfolio is very inactive while being tax and fee efficient.  Therefore, it can target returns similar to a passive indexing strategy while maintaining similar tax and fee efficiency.

Orcam Moderate Countercyclical

The Moderate Countercyclical strategy is Orcam’s version of a Balanced 60/40 style Portfolio. This portfolio is designed to reflect a globally balanced stock/bond portfolio over the course of the business cycle, however, there are significant flaws in the current 60/40 which allow some room for improvement. The Moderate Countercyclical portfolio adjusts the traditional 60/40 to overcome two major flaws:

1. A 60/40 portfolio has a static risk assumption, however, we know that the 60% stock component will drive returns disproportionately and will expose the investor to far more risk late in the business cycle than it does early in the business cycle.  This means that a 60/40 portfolio is likely to expose the investor to significantly more risk of permanent loss late in the cycle (years such as 2000, 2008, etc) than it will early in the cycle. We adjust the portfolio depending on where we are in the market cycle in order to create greater parity between the investor’s risk profile and the underlying risk of the asset classes.

2.   The current fixed income slice of a 60/40 is virtually guaranteed to generate low real returns as the structure of interest rates is so historically low. To counter this the composition of the fixed income portfolio deviates from the aggregate index in order to increase the odds of generating positive real returns in a low interest rate environment.

The Moderate Countercyclical portfolio is designed for the investor who can stomach fairly large drawdowns, but is looking for less volatility than stocks while also trying to generate better returns than a static 60/40 portfolio which is virtually guaranteed to expose you to low bond returns and high stock market risk in the coming 20 years.

Most importantly, this portfolio is very inactive while being tax and fee efficient.  Therefore, it can target returns similar to a passive indexing strategy while maintaining similar tax and fee efficiency.

Orcam Aggressive Countercyclical 

The Aggressive Countercyclical portfolio is designed to focus on the risk of purchasing power loss over long periods of time. This portfolio invests in a globally diversified set of low fee index funds that are designed to be overweight stocks during the business cycle’s expansion phases with a reduced overweight to stock market risk during the contraction phase of the business cycle.  This portfolio always overweights the risk of purchasing power loss relative to permanent loss, however, by acting in a countercyclical manner the portfolio counterbalances the average investor’s tendency to be overweight stocks when they are riskiest late in the business cycle as well as the tendency to be underweight stocks early in the business cycle when stocks become less risky.

This countercyclical approach is ideal for investors who are seeking to maximize returns, can stomach large amounts of permanent loss risk and have a legitimately long-term time horizon. The aggressive strategy is the more equity focused version of our Moderate Countercyclical portfolio and will seek to generate higher returns with the understanding that stocks tend to generate strong 5 and 10 year rolling returns, but also seeks to protect the investor from substantial downturns during periods in the business cycle when large downturns are most probable. This portfolio allows the investor to be aggressive, but improve the odds of reducing their risk to permanent loss by better shielding the portfolio from stock market declines during periods when the equity markets are riskier than normal.

Most importantly, this portfolio is very inactive while being tax and fee efficient.  Therefore, it can target returns similar to a passive indexing strategy while maintaining similar tax and fee efficiency.

To learn more about the way we think about portfolio management please see some of our white papers and research below:

 

¹ – Roche, Cullen.  2014.  Countercyclical Indexing.

² –  Roche, Cullen. 2016. Understanding Modern Portfolio Construction.

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