Upcoming Portfolio Changes

Starting today and over the next couple of weeks, we are placing several trades in clients’ portfolios. These trades reflect changes in the market environment and some model adjustments we have made to more efficiently express our outlook. The purpose of this WJNotes is to provide insight into our money management process, to explain the changes to the model and its effect on clients’ portfolios.

To begin, it is important that clients understand how we think about managing money, and it can be boiled down to two central investment themes: we believe in diversification and we believe in investing in assets that are undervalued.

At the highest level, we start with diversifying stocks with bonds to protect clients’ portfolios in stock market sell-offs and to reduce volatility. Going a step further, we then diversify stocks across the globe, and diversify bonds in terms of the bonds maturity and the various types of credit risks they entail. An additional source of diversification is through alternatives. These strategies offer a different pattern of returns than stocks or bonds, and therefore increase the portfolio’s diversification.

Our other core theme is value investing. Simply put, it is our preference to buy inexpensive investments and sell expensive ones. Using a variety of metrics, we can assess how inexpensive an asset class is, and based on our analysis, will over/underweight an asset class relative to the benchmark.

The changes that we are making to the portfolios do not compromise on either of these two core investment themes. Here is a brief overview of the model changes we are making:

As previously discussed, we believe in investing in assets that are undervalued. This is a profitable long-term strategy, but can be difficult in the short-term. It can take years for an expensive market to correct back to its fair value and likewise for an inexpensive market to appreciate up to its fair value.

Based on this issue, we have modified our models to monitor not just the value of the various markets we invest in, but also whether they are trending higher or lower. The result is that we will continue to hold on to an expensive investment that is trending higher, until that trend starts to reverse. Similarly, we will wait to buy an undervalued investment that is falling, until that trend starts to reverse higher (not catching the falling knife as they say).

This trend overlay is the greatest change we have made in our models, however there are some smaller changes that improve how we implement the portfolio.

From now on, all our tactical adjustments will be made with low-cost, passive index funds. This will reduce the amount of trades we place in the future and reduce the overall mutual fund expense ratio.

An additional change is the reduction of the total alternatives allocation. The main reason is that we are now holding more aggressive diversifiers within alternatives, and thus do not need to hold as many of them to maintain a similar level of diversification. Since these alternative funds generally have higher fees, reducing their total weight will also lower mutual fund fees on the overall portfolio.

In summary, the changes we are making allow us to implement our core investment themes (diversification and value) in a more efficient manner. We continue to be long-term, value focused managers, and expect these modifications to improve our efforts in helping clients reach their goals and objectives. If you have questions about these changes or any of the trades, please contact us.

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