Our investment approach can best be described as Tactical Asset Allocation. While we believe that it is not possible to “time the market” on an ongoing basis, it is possible to exploit changes in economic conditions by adjusting portfolio holdings. For this reason, we develop two “portfolios” for each client. One is a benchmark portfolio. This benchmark is what we measure our progress against. The other is the actual, or working, portfolio. While the benchmark remains static, the actual portfolio is adjusted to current economic conditions, and then rebalanced on a regular basis to maintain those current allocation targets. Investment Management is a separate service from Financial Planning.
At Navion Financial Advisors, we take a goals-based approach to investing, and have broken the investment process down into seven distinct steps.
As Yogi Berra once quipped, "If you don't know where you're going, you'll wind up somewhere else." If you don't know what you're trying to accomplish how will you know when you've accomplished it? This is one of the most crucial steps you can take. This step is best accomplished by preparing a financial plan. At the very least, you'll need to know what rate of return you are trying to achieve and what will be the timing of the cash flows in and out of the portfolio.
Once we have a plan in place, we "stress test" this plan by reducing the returns assumption to the point where the results of a rigorous simulation[i] begin to show plan failure.
After setting your goals, the focus turns to the subject of risk. Specifically, how much risk must be assumed in order to accomplish the desired goals? To be useful, a risk assessment must be both quantitative and qualitative. By this I mean that not only is it important to know how much risk could cause a plan to fail, but we also need to know how much risk the portfolio owner can stand before abandoning the current plan of action. Therefore, questions as to time horizon and self-descriptive risk tolerance are important, it is also important to include questions that address behavioral finance.
Now that we have defined our goals and determined our risk tolerance, we determine where these two "intersect". It would be useless to construct a portfolio with target goals that are higher than can be attained with an acceptable amount of risk. Conversely, it would be dangerous to build a portfolio that incorporates more risk than is necessary to accomplish the goals. Therefore, we will now construct a "portfolio" which is designed to accomplish the client’s goals with only the amount of risk necessary.
First, we determine which asset classes are appropriate for the portfolio. We then allocate[ii] these classes on a percentage basis taking into account the risk and return of each asset class, and correlation of each to the others. This becomes our benchmark, or policy portfolio.
The Statement of Investment Policy will govern how the portfolio is managed. At its most basic, this document will include the objectives, time horizon, risk tolerance, expected return, benchmark portfolio, prohibited transactions, investment parameters (such as tax concerns), and any other relevant information which may influence how we manage a portfolio.
The Statement of Investment Policy should be used in conducting portfolio reviews. Change in circumstances may require that the document be updated.
While the policy portfolio is designed to address goals and risk tolerance, some variation from this will occur due to current economic conditions. Think of the policy portfolio as two dimensional (risk and return), while the target portfolio is three dimensional (risk, return, and what is going on in the world). The policy portfolio asset allocations will be over weight, target weight, or under weight. It is these target allocations to which the portfolio will be re-balanced periodically.
First, we determine our “investment posture”. We believe that there are times to be more aggressive (within the client’s overall risk tolerance), and times to be more conservative. These can be due to market conditions, or whether the client is on track to accomplish their goals. If the client is well ahead of target, then we can afford to scale back on risk. The target portfolio allocations will be modified as economic conditions change[ii].
Next, individual investment selections are made[iii]. Drawing from global fiduciary standards, investments in each asset class are examined for risk, expenses, relative performance (to peer groups) management, and consistency. Using a formula, investments are given a fiduciary score.
If there is an existing portfolio that we are being asked to manage, we will review the existing investments according to these standards. Decisions to sell existing positions are made by weighing the benefits of making a change for policy or performance reasons, or keeping an investment that does not meet these standards in order to minimize tax liability, or because of sentimental reasons, as in the case of an inherited asset.
The portfolio will be reviewed for adherence to asset allocation targets and risk management on a regular schedule. The underlying holdings are monitored on an ongoing basis. Changes in any of the characteristics mentioned above will warrant review and possible replacement.
To make changes due to allocation percentages, an asset class within the portfolio must be at least 20% off target. Thus, if an asset class has a target of 15% of the portfolio, that asset class will need to be either less than 12% of the portfolio or more than 18% before a change will be made. Obviously, if a holding is removed from the portfolio, something will have to be found to take its place in order to maintain allocation targets.
The importance of a consistently applied process cannot be overstated. There are many variables in the investment markets that are beyond our control. Our process provides us with a ready response as those variables change, so that we might better help our clients accomplish there goals, and make the most of their lives.