In the short run, market performance and volatility are merely background noise. They do not mean much—except how you react—and you should not react if you have a well-developed plan. What matters most is results over-time and having the fortitude to make investments for the long-term. Internet or day-trading is a fools game, and the only true winners in the stock and bond markets are those who understand that market dynamics as well as security return characteristics are not ultimately determined by particular equity selections. The vast majority of a portfolio’s return is due to asset allocation in terms of the particular mix of equities, fixed income, and cash as well as portfolio weighting in terms of company size (market cap) in addition to growth and value holdings—and shifting the allocation as the economic cycle plays out over time.
The key to investment management is balancing the prevailing trends of the market with the principal of regression analysis, or gauging risk in terms of the speed of the market to switch gears as the economy matures. This means asset class diversification, which depends on two prevailing factors: where the economic cycle is trending and where you are in terms of your own individual or family life cycle.
Our approach is to create a customized portfolio for each client, with the goal being to outperform the general market cycle over time, with a careful eye towards managing risk. It is a combination of qualitative and quantitative analysis. We start first with a top-down approach—where the economy is headed. We then transition your assets into equity and fixed income instruments, and the percentage allocated to each macro asset class will depend on such factors as your total account holdings, the degree of qualified assets or 401-k type funds you have available, your expected tax bracket, as well as your expected holding period. For example, the older the client and/or shorter the expected portfolio holding period, the greater propensity will be to use fixed income. The type of fixed income instrument (corporate, municipal, treasuries or mixture of the three) as well as duration or weighted average maturity will depend on such factors as your tax bracket and prevailing relative interest rates and credit quality. We believe in active management of fixed income holdings because such an approach allows the portfolio to better weather the principal reducing tendency of static holdings in an increasing interest rate environment.
The equity portion of the portfolio will consist of core holdings that mimic the key indices of the market, e.g. the S&P 500, the S&P 400, the Russell 2000. The S&P index alone accounts for some 80% of the total domestic market and will account for the lion-share of your equity holdings; the rest of the core equity structure will consist of mid-cap and small-cap equities, which will include international and emerging market holdings.
Passive instruments, such as exchange traded funds, will often be used as they are tax-efficient and offer relatively low-expenses. Selected fund managers may be used in some instances for smaller company holdings and international equities, as it has been shown that active management in these particular asset classes can add value (or, in stock market terms, alpha).
A tactical overlay or opportunistic weighting may be added to certain client portfolios—opportunistic, meaning, in some instances, individual equity holdings offering considerable long-term (or in rare instances, short-term) potential or individual country/industry concentrations offering compelling value, e.g., oil exploration or oil service companies in 2004–2006. Such tactical overlays or satellite holdings will not account for more than 20% of the equity portion of the portfolio, and in most instances no one equity position will exceed 4% of total equity value.
In some client situations, alternative investments, such as private equity (taking advantage of company restructuring), hedge funds, art/collectables, and real estate may play a roll in investment planning. New Castle Investment Advisors can help guide your considerations.