Investment Philosophy Statement
Overview
The investment philosophy of the Bryan-Billauer-Kozo Financial Strategies Group is based on the compilation of several academic and institutional investment management strategies. The portfolios are structured primarily for high net worth investors and institutions and incorporate the following techniques:
· Dynamic Asset Allocation
· Core-Satellite Portfolio Construction
· Tax Efficiency
· Systematic Rebalancing
· Ongoing Review
Dynamic Asset Allocation
Asset allocation is the process of attempting to maximize one’s portfolio objectives while minimizing the associated risks. In order to do this, the portfolio is invested in various asset classes such as stocks, bonds, and cash. The returns of these asset classes tend to be affected by different factors and thus, face different risks. Although asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns and past performance is no guarantee of future results, it has historically helped to reduce the risk of a portfolio if implemented properly.
Traditional asset allocation uses a fixed ratio to distribute assets among various asset categories. The ratio is typically determined by the investor’s age, risk tolerance, or financial objectives. While this approach may reduce risk, it makes little attempt to adjust the distribution of assets to take advantage of market conditions and may leave significant portions of the portfolio vulnerable to market downturns and conversely not well positioned for market upswings.
Dynamic asset allocation, like a “fixed asset allocation strategy,” seeks to reduce risk through diversification among different asset categories. Using dynamic asset allocation allows us to weight investments based on those categories which we deem to have the greatest potential for positive returns, given the current market conditions. The allocation of assets becomes dynamic when tactical changes are made in response to market conditions and perceived opportunities for profit or reduction of risk.
The asset allocation of the Chief Investment Strategist of Wells Fargo Advisors is used as a benchmark to help guide the asset allocation decision.
Core-Satellite Portfolio Construction
Once we have defined the asset allocation model to be implemented based on one’s investment needs, the next decision is how to fulfill each asset class. Our methodology involves using a Core-Satellite approach to represent each asset class. Core-Satellite portfolio construction is an institutional strategy that provides a framework for asset allocation to be implemented with more purity and potentially less cost than portfolios limited to 100% active management. Simply put, a Core-Satellite portfolio blends index and active managers in an attempt to achieve more consistent portfolio tracking to asset class benchmarks than an all active manager strategy provides.
Index investments form the core components and the active managers constitute the satellites. The core components are selected based on their ability to closely track the benchmark index. Satellites will be chosen based on their risk/reward characteristics, internal expenses, turnover, and style consistency. The percentage allocated between indexes and active managers will depend on the perceived inefficiencies within the asset class and the tracking error of the satellite for review. Tracking error can be defined as the standard deviation (measure of volatility or risk) of the managers' quarterly alphas (excess return over the benchmark index). In other words, the higher the tracking error of a satellite, the more volatile the investment has been with respect to its benchmark. Special consideration is given to managers that have a high tracking error but also have a high information ratio. The information ratio measures the consistency with which a manager beats a benchmark and could help to explain the high tracking error.
Tax Efficiency
We have two classes of accounts that we manage for our clients - Tax-Sensitive and Tax-Advantaged. With our Tax-Sensitive portfolios, we focus on our after-tax rate of return. We understand that the Tax Efficiency of a portfolio is especially important for taxable investment accounts owned by individuals and institutions operating at the highest marginal tax brackets. Tax Efficiency is derived by dividing the after-tax (or tax-adjusted) returns by the pre-tax returns of a portfolio. The highest possible score would be 100%, which would apply to a portfolio that had no taxable distributions.
We improve the tax efficiency of the portfolio using three different techniques:
- Adding more to index investments which have historically paid very little in capital gains until sold
- Evaluating the risk and reward potential against the potential tax inefficiency of an active manager with high turnover before they are selected as a satellite
- Seeking out tax-loss harvesting opportunities to realize losses that may help offset gains
With our Tax-Advantaged portfolios, we assume that the investments are held within a qualified plan, foundation or other tax-deferred vehicle or have a large tax loss carry-forward to offset future realized gains. These portfolios are managed for total return without regard for the taxes that might be incurred.
Systematic Rebalancing
We believe systematic rebalancing is essential to maintaining the consistency of an investment account’s returns and risk profile. Rebalancing requires the investor and advisor to set up a strategic asset allocation (as stated above) with targeted percentages in each category. Generally once per year and sometimes as often as once per quarter, the assets are rebalanced back to their fixed target percentages. This is accomplished by reducing the amount in asset classes that have exceeded their specified percentages and adding to the asset classes that have dropped below their original designated percentages. The frequency of rebalancing in a given year depends on the type of account: Tax-Advantaged or Tax-Sensitive.
A rebalancing strategy requires strict discipline.
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