Portfolio Construction Framework: Conviction in Diversification
When crafting portfolios, we employ techniques that are traditionally utilized by sophisticated investors such as the pensions, endowments, and other institutions that we have managed assets on behalf of for thirty years. The goal of our approach is to build an optimized "efficient portfolio", in simple terms, one that seeks to maximize the amount of potential return for a given level of risk. To accomplish this, we employ a philosophy known as the Core and Satellite approach to portfolio construction. Core investments provide a broad foundation comprised of U.S. stocks, U.S. fixed income and Developed Market International Equities. The Core is then augmented by investing in Satellite Asset Classes (View Chart), such as Emerging Market Equity and Debt, Real Estate Securities and High Yield Bonds.
Using this approach, investors and their advisors may:
Lower the volatility of their portfolio by diversifying its sources of risk.
Broaden the opportunity set for potential portfolio returns.
Increase the likelihood of meeting specific financial goals.
The Core is designed to deliver efficient exposure to asset classes that are broadly representative of "traditional" stock and bond markets (much of this market representation comes in the form of equity and interest rate risk). While implementation strategies can vary, we believe that a combination of active and passive strategies can be used to develop a solid core for most investors.
Satellite strategies generally deliver higher levels of alpha (risk adjusted returns over global market benchmarks) or exotic beta (exposure to risk factors with low correlation to global markets) and can enhance expected returns, while lowering overall portfolio volatility.
Managing Risk: Our Approach to Asset Allocation
At Congress Asset Management, LLC experience has shown us that the greatest threat to investors achieving their goals, are extreme portfolio losses over a short period of time, or "drawdowns." In the years following the global financial crisis of 2008, both retail and institutional investors have had to face the following realities:
Drawdowns can derail even the most carefully crafted financial plans and spending policies.
More "traditional" methods of asset allocation may not deliver an optimal risk-return profile to investors.
To help mitigate drawdowns, we employ an institutional-quality asset allocation framework that is focused on spreading risk across asset classes. We prefer to view portfolios not as a collection of stocks and bonds, but rather collections of asset classes that are either Return-Generating or Risk-Managing in nature.
It is our belief that separating exposures by “return-generating” and “risk-managing," is a more effective approach than the more widely used method of labeling them as either "Equities” or "Fixed Income." Using this process, advisors and investors can:
Distinguish between and manage various sources of portfolio risk to improve portfolio structure and efficiency
Incorporate return generating opportunities and/or volatility-reducing asset classes to a portfolio
Increase the likelihood of meeting their specific financial goals
► Our 3-Step Portfolio Construction Process:
5-Year forward looking proprietary Capital Market Assumptions are established
The Core/Satellite Asset Allocation Framework is applied
A comprehensive evaluation of risk (systematic and idiosyncratic) and return (capital appreciation and income) is considered
► A Deeper Dive on Our Approach:
Our asset allocation approach is less sensitive to expected return assumptions because it places greater emphasis on risk forecasts
The risk allocation for a given portfolio is broken down by each individual investment exposure. Optimal risk exposure divides risk among asset classes, producing low-cross correlation.
We consider a very broad range of potential asset classes to allocate to
We separate the portfolio into return-generating assets and risk-mitigating assets, and allocate to these pools in accordance with investor-specific constraints and objectives
The risk-mitigating portion of the portfolio is customized according to an investor/institutions' specific goals
We seek to incorporate asset classes that have an imperfect correlation to the core holdings (i.e., public developed large cap equity) (lower correlation is better) and that have an independent source of returns.
We have conducted extensive research on how to optimally model and size Satellite exposures in client portfolios, which we consider a competitive advantage.