The following tenets, steeped in empirical research and developed over decades advising assets at global investment banks, are the basis of our investment approach:
Our philosophy is grounded in modern portfolio theory and asset allocation theory (Brinson, Beebower and Hood, 1986). Modern portfolio theory, which won a Nobel prize in economics for Harry Markowitz in 1990, demonstrates that there is a relationship between risk and return and when non-correlating assets are added to a portfolio, a higher portfolio risk-adjusted return is attained. Asset allocation theory identifies three sources of return: asset allocation, security selection and timing. The asset allocation decision is shown to be by far the largest determinant of variation in returns. Therefore, we concentrate efforts on the total portfolio composition and how assets are allocated. View a list of asset classes that we continually research.
The asset allocation decision is based on a long-term macroeconomic view, not short-term anomalies. We consider many variables when constructing portfolios including, but not limited to, expectations for: inflation, deflation, corporate earnings, geopolitical concerns, interest rates and currency valuations. We seek to exploit proven long-term relationships among asset classes when constructing portfolios. For retirement plan portfolios we do not pick individual securities or time markets.
We believe the cost to invest is critical in portfolio construction. Portfolios are constructed to represent the asset classes and markets we target at the least expensive cost to achieve our investment goals.
Many of our stock asset classes are represented by indexes for several reasons: 1) Indexes provide effective representation of asset classes and markets. 2) Indexes are offered in the marketplace at very low costs. 3) Indexes can be very tax-efficient. We track several hundred indices and evaluate the appropriateness of each in terms of how it may fit into our investment outlook.
We pay particular attention to managing risk in portfolios. Two primary measures that we review are volatility and downside risk. We measure these for individual asset classes and for the overall diversified portfolio. Decisions to add new asset classes are based on how they impact the overall portfolio's expected return, volatility and downside risk.