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 Articles
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By James H. Shelton, CFA
Chief Investment Officer August 1, 2008 As market performance through the first half of 2008 proves, the investment landscape has changed to a much more challenging environment. Credit market stress and commodity price inflation threaten global economic expansion. The collapse of the housing and credit market bubbles has reduced the appetite for risk-taking and sharply decreased credit availability. It seems clear that past equity market performance may be difficult to match in future years. How can investors position portfolios to protect and build wealth in these volatile times? We believe the answer begins with adhering to a disciplined investment philosophy that includes appropriate diversification and a focus on the long term. After all, long term investment success is more dependent on not losing money in down markets than on making money in the good times. This allows a portfolio to maximize the power of compounding. This article examines an investment philosophy that seeks to achieve the wealth objectives of each of our clients. Kanaly’s Investment PhilosophyAt Kanaly Trust, the foundation of our investment philosophy is built on the idea that a client’s wealth is irreplaceable. To be consistent with this premise, wealth should be invested in a way that protects capital and allows it to grow at a rate that exceeds inflation and consumption needs, without taking undue risk. Most importantly, portfolios should be designed to reduce volatility while enhancing expected returns to maximize the benefits of investment compounding. Here’s a simple example to illustrate the impact of lower volatility on compounded returns. Consider two portfolios over a three-year period: annual returns on Portfolio A are 0%, 0%, and 30%; annual returns for Portfolio B are 10%, 10%, and 10%. Assuming you had $10,000 to invest, which portfolio would you prefer? After three years, Portfolio A would be worth $13,000, but Portfolio B would be worth $13,310, or $310 more than Portfolio A. While the average return on both portfolios is the same, Portfolio B creates more wealth because it compounds a more consistent, less volatile return stream. In order to achieve the wealth objectives of individual investors, we believe an investment philosophy must include the following key components: Institutional-quality investment solutions customized to client objectivesMuch attention has been paid to the stellar returns of certain institutional investors such as the endowments of Harvard and Yale universities. Many of the investment solutions utilized by these endowments are increasingly available to affluent individuals. We use a rigorous due diligence process to identify superior investment managers we believe are representative of a given asset class and have a high probability of repeating excellent historical performance. Finally, our optimization process determines the most effective mix of investment solutions for each client based on individual factors such as risk tolerance, time horizon, and return expectations.
Sources: Yale Endowment Report A thoughtful, forward-looking asset allocation for the long term A well-diversified portfolio constructed using a core/satellite approachOn average, most traditional investment strategies merely track the performance of market indices, or underperform net of fees and transaction costs over a full market cycle. Why is this true? Many traditional asset classes are highly efficient, and managers are typically constrained in how they can invest, resulting in little opportunity for active managers to add value. A potential solution is known as “core/satellite” portfolio construction. We create the “core” of a portfolio by employing cost and tax effective index-based strategies in asset classes where it is difficult for active managers to beat the indices. The “satellite” consists of managers that consistently add value and outperform due to unique strategies, less efficiency in their asset class, and/or fewer investment constraints.
An appropriate allocation to non-traditional or alternative investments
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