This piece marks the start of a new article concept here on the ETFs & Portfolio Strategy page at Seeking Alpha. The concept is for a money manager or RIA to field a hypothetical portfolio construction question from an SA user about how to best construct a portfolio that will help them meet their financial goals and then proceed to build an effective portfolio that will take their risk/reward profile into account. All participants in this series are real-world professional investors who are available to help individuals and companies construct intelligent portfolios.
Kicking off our 'Build My Portfolio' series is Adam Orlov of Chicago-based Holos Asset Management. Holos' portfolio construction process begins with broad analysis of various global macroeconomic factors, in addition to individual securities’ risk/return profiles. Using these analyses, Holos employs a 'value-based' (as opposed to a 'price-based') approach to portfolio construction. Holos creates its portfolios using cost-effective and liquid products, all held in individual managed accounts which are within the client’s control at all times.
I am 39 year old self-employed individual who makes roughly $250k a year after taxes. After all expenses, I have roughly $25k a year to put into savings. My wife is able to put away about $10k a year into the 401k her work offers her. That money is split between the S&P 500 (75%) and 5 Year Treasuries (25%).
My long-term financial goals are as follows: Have enough money to send both of my kids (currently aged 4 and 1) to private universities and be able to retire by the time I'm 70. Other family members of mine have lived to old age - my grandfather is still alive - he just turned 95. My father is 70 and has never had a serious health problem before so it's safe to assume I will need enough to live for 20-25 years in retirement. Please help me build my portfolio so I can achieve my long-term financial goals.
San Diego, California
You are starting out with the right perspective: your investment portfolio should be managed with long-term performance in mind. The vast majority of investors are not trading professionals, glued to a monitor for every moment of the business day with huge technical resources at their disposal, and building assets should be about optimizing long-term risk-adjusted returns. The best way that we know of doing that is by using rigorous fundamental analysis to intelligently take advantage of global equity and debt markets. Analysis of fair values versus market prices for securities can enable you to make good decisions about how to allocate your resources, and diversifying globally can help to mitigate risks while seizing the best buying opportunities available.
In addition, allowing your investment decisions time to prove themselves by resisting the urge to trade frequently can improve returns through the performance of the securities in your portfolio and through lower trading costs and taxes. And don’t underestimate how important those lower costs can be: small annual savings can compound to dramatic differences over the life of your portfolio.
At Holos, we manage our clients’ assets according to these principles and here is how we construct the portfolio we would recommend for you:
1. We take advantage of in-depth fundamental research on macroeconomic and market data from around the world; this research examines factors such as inflation, interest rates, economic growth, and earnings and dividend yields. That research is used as the basis for valuation-based asset allocation strategies – these models favor asset classes that are attractively priced relative to fair value.
2. Each of our portfolios is constructed with broad, global diversification – both geographically and by asset class. Equity and debt securities, representing governments and companies (of all sizes and from all sectors), are included in each portfolio.
3. We believe that deviations from fair value take time to correct, but we can’t be exactly sure when those corrections will occur. With that in mind, our approach trades infrequently and allows securities the time required to revert to fair value, without trying to ‘time’ the market. We believe that a one-year holding period is often the ideal average duration for dynamic valuation-based portfolios of this type. While we can monitor valuation changes on an ongoing basis, we rarely reallocate our client accounts more frequently than once per year, unless dramatic market conditions warrant it. We believe that attempts to pick ‘tops’ and ‘bottoms’ often diminish returns and while increasing trading and management expenses.
4. Keeping costs under control is critical for long-term performance. We almost exclusively use ETFs, which offer us both fundamentally-weighted index composition for many different markets and extremely competitive expense ratios. In addition, our method of using a select arsenal of portfolios for all of our clients is one way in which we keep our maximum management fee at 0.75% of assets; less as an account size increases.
These principles have fueled our performance since inception and continue to guide us. Our bottom line advice for you, James, would be to invest in the strategy we offer which favors equities over fixed income, at a recent ratio of about 62% to 38%. The securities we would use in your account (in the order of their current representative weightings in the portfolio) are as follows:
- Vanguard U.S. Total Bond Market (NYSEARCA:BND)
- WinsdomTree U.S. Large Cap Equities (NYSEARCA:EPS)
- WisdomTree International Developed World Large Cap Equities (NYSEARCA:DOL)
- WisdomTree U.S. Small Cap Equities (NYSEARCA:EES)
- WisdomTree International Developed World Small Cap Equities (NYSEARCA:DLS)
- PIMCO 1-5 Year TIPS (NYSEARCA:STPZ)
- WisdomTree Emerging Market Large Cap Equities (NYSEARCA:DEM)
- WinsdomTree Emerging Market Small Cap Equities (NYSEARCA:DGS)
- iShares Emerging Market Government Debt (NYSEARCA:EMB)
- iShares 1-3 Year International Government Debt (NASDAQ:ISHG)
- WisdomTree International REITs (NYSEARCA:DRW)
- Market Vectors Hard Asset Producers (NYSEARCA:HAP)
[Editor's Note: Adam declined to give exact weightings for the ETFs he selected, which are presented in order of most to least heavily weighted. As Adam explained, 'For advisors like us who differentiate based on approach and a specific take on dynamic asset allocation, giving away the weightings is giving away a little too much.']
We use these asset classes to give your portfolio broad exposure to global equity and debt markets. Our current weightings reflect our belief that U.S. large cap equities are currently more favorably priced than small cap stocks, either in the U.S., internationally, or in the emerging markets. We also still believe that there is value in U.S. government and mortgage securities, and in inflation-protected bonds, hence our strong weightings in those categories.
We use Vanguard’s BND ETF for its broad holdings of U.S. government and corporate investment-grade debt, very competitive expense ratio, and attractive duration profile. For TIPs we prefer Pimco’s STPZ because of its extremely short duration – we want to guard against inflation risk and the shorter our TIPs duration, the more cleanly we separate that objective from interest rate risks. We use iShares’ EMB and ISHG for emerging markets and international developed debt, respectively, due to their intelligent construction and competitive fee structures.
On the equities side, most of our exposure comes through the WisdomTree family of ETFs. We favor WisdomTree funds because of their fundamental index construction – they structure the ETFs we like to use based on firms’ earnings (in the U.S. market) or on concrete dividends paid (in international and emerging markets).
Standard market cap weighted products increase a firm’s representation as its market price goes up – the higher a firm’s price goes, the bigger the slice of the index that it becomes. WisdomTree’s approach is more in line with our overall take on fundamentals-based portfolio construction and complements our philosophy.
For commodities producers, we use Market Vectors’ HAP ETF. It tracks the performance of a global array of firms engaged in producing (and providing ancillary services for) hard assets – as opposed to some funds which actually track commodities’ futures prices.
The characteristics of these securities are integral to our overall approach, which is a thoughtful and disciplined way to help you optimize the risk-adjusted returns you can realize on your portfolio. We look forward to working with you!
Disclosure: We are long all of the securities specifically mentioned in this article.
Disclaimer Statement: This article is for informational purposes only and does not express an opinion or constitute an offer by Holos or any of its officers, directors, employees or agents to buy or sell any particular security or financial instrument or to provide any investment advice or service. All investment management services are offered through the presentation of Securities and Exchange Commission Form ADV, personal contact with Holos representatives and the execution by you and Holos of an investment advisory agreement.
The information in this article is descriptive of the investment strategies of Holos and the services and strategies described may not be available to, or suitable for you. Any strategy selected must be consistent with your investment objectives, time horizon and financial goals as well as needs. These services may be subject to change without reference or notification to you. These methods of investing subject you to the risk of loss, including the risk of losing all invested capital. There are also tax implications of these decisions and we do not provide tax advice.
This article may contain facts, opinions, data and recommendations (including forward looking statements) of third parties or organizations that Holos believes to be reliable, but Holos does not warrant or guarantee the accuracy of such information or otherwise endorse the views of such organizations.