Equity Portfolios – Targeted Premiums™
When designing investment models, our philosophy is that while there is no universal investment strategy that is ideal for all investors, there are certain market fundamentals that should be used in every portfolio. Professors Eugene Fama and Kenneth French famously documented the “size and value effects,” showing that small cap stocks tend to outperform large cap stocks in the long run, and that value stocks (stocks with a low price-to-earnings (P/E) ratio) outperform growth stocks (those with high P/E ratios) over long horizons as well. These effects hold across time and around the world. In addition to size and value premiums, emerging market equities have tended to generate superior returns over equities of developed countries (see Figure 1 below).
Directional investment models take advantage of these long-run market premiums by specifically targeting segments of the market that are expected to have higher long term returns. This is known as our Targeted Premium™ approach. For clients with longer time horizons or with more ability to take risk, we increase our allocation to these asset classes with higher expected returns, thus allowing us to tailor a client’s investment portfolio to their specific needs using both overall portfolio allocation and targeted asset investing.
Our equity portfolios are broadly diversified with funds holding over 8,000 stocks, heavily reducing the possibility of large drops in performance as a result of inadequate diversification. We are very cost conscious when it comes to the funds we choose to invest in, using among the lowest expense funds in the industry, for example, our Moderate Targeted Premium™ (TP-1) portfolio expense is 0.39% while the Morningstar average expense for a similarly designed global portfolio is equal to 1.36%. The implication of this is that even at a fee point of 1% fee plus fund expenses, the total Directional portfolio expense is about the same as what the average investor is paying without any of our services.
In many of the asset classes we use in our investment models, we employ institutional class investments thus offering exclusivity and the opportunity to outperform standard market indexes while keeping costs down. We have had a long term relationship with Dimensional Fund Advisors (DFA) and the inclusion of the DFA funds in our client portfolios has resulted in a return premium over standard index funds over the last 10 years. We will continue to search the market for other opportunities to increase returns and reduce portfolio risk through the selection of cutting edge investments.
An aspect of investing that is often overlooked is the tax consequences of investment decisions. We incorporate multiple levels of tax sensitivity in our investment process. Some of the methods employed are described in detail below:
- Directional utilizes tax-efficient investment funds and tax-managed investments for taxable accounts in specific asset classes (this is important, as even passive funds may have issues remaining tax efficient if the strategy is focused on an area of the market that requires a lot of rebalancing to stay true to the style target, such as value or small cap strategies).
- We layer in asset placement when client appropriate (i.e., putting less tax efficient investments in tax deferred accounts).
- In taxable accounts, we actively tax loss harvest year-round based on each client’s unique basis in each position.
- When rebalancing or adjusting the asset allocation, we avoid creating short term capital gains whenever possible. Furthermore we consider future contributions of cash as we analyze transactions that could create a recognized taxable gain. We also consider the withdrawal strategy for retired clients who plan to take regular income from their investment accounts.