My Investment Philosophy: Capital Appreciation, Global, Top-Down

As I begin my market blog, I would like to start with an explanation of my investment philosophy. Over the next several entries, I will address my philosophy, my assessment of the current economic environment, my strategy for these conditions, and the impacts of that strategy on my investment portfolio.

To begin, my investment goal is capital appreciation, as opposed to, for example, capital preservation or income generation. This doesn't mean that preserving my capital is not important to me -- you can't increase it if you squander it! Rather, this means that, as there is normally a trade off between risk and reward (with occasional exceptions!), I am willing to accept moderate to higher risk (beta) in my investments in pursuit of capital appreciation and understand that the overall risk of my portfolio will often exceed that of the S&P 500. As a result, I am willing to accept (though not necessarily enjoy!) short-term draw-downs in pursuit of long-term gains.

Though I prefer to err in the favor of focused investment plays versus over-diversification, I believe in looking globally for opportunities. I am in favor of diversifying across asset classes and divide my investments among five -- equities, real estate (in the form of real estate investment trusts and equities such as hotels and homebuilders, etc.), fixed income, commodities, and currencies. For the purposes of this discussion, however, I will focus only on the first two -- equities and real estate issues.

My investment process consists of first developing macro-economic views and identifying trends (as well as modifying these assessments as conditions change), then determining broad asset allocation guidelines among the five classes listed above. I invest in these different classes not in order to spread myself thin -- though they can provide some useful uncorrelated diversification -- but to provide multiple angles from which to approach a specific investment theme. Fairly consistently, however, equities -- what we focus on here -- have been the largest of the classes.

Working within these broad allocation guidelines, I proceed to identify opportunities through a top-down approach, beginning with the selection of the most promising national markets and industries. Certainly, there are opportunities to be found everywhere, but why swim upstream? From my perspective, working down from the macroeconomic picture helps narrow the search and increase the odds of success. Instead of picking an equity in a weak market or industry, where it will have to buck the trend, why not pick the best opportunity in a promising sector?

Next, after identifying the most promising markets and industries, I select equities based on a combination of strong fundamentals and growth potential. To determine this, I use both discounted cash flow and relative valuation measures, comparing the equity against both the broader markets and its own industry/sector. Once I have identified a desirable investment through fundamental analysis, I defer to some basic technical analyses to select specific trading entry and exit points. (Though I am not a technical trader, I consider this an important factor which reflects both supply-demand dynamics and market sentiment. Though I do not believe in blindly following the herd, I also want not to be run over by it.)

In the end, I seek to build my portfolio around a core of high-quality equities and REITs which show the potential for "growth at a reasonable price" in primarily a "buy and hold" approach. However, to account for short-term economic/market conditions and opportunities, I look to achieve additional alpha through futures, options, and shorts. I measure my success or failure by benchmarking against both the S&P 500 and the MSCI World Index -- reflecting the high percentage of international positions in my portfolio -- seeking returns which surpass both.

In my next piece, I will address my assessment of the current investment environment.