An Investment Process Designed to Withstand Uncertainty

A few weeks back during peak chaos with markets and headlines flashing red nearly every day, we wrote a commentary titled, “Portfolio Management Strategy Amid Market Chaos” (https://ballastplan.com/portfolio-management-strategy-amid-market-chaos/), that focused on remaining calm during troubling times. Here is the opening paragraph from that commentary written on March 19, two trading days prior to the current market bottom, “During periods like this, it is important for all of us to step back, take a breath, and attempt to gain some amount of perspective on what is happening. Just over one month ago, domestic markets were celebrating all-time highs and the economy was cruising. Today, the market is in “panic mode” and approaching an attitude of despondency”. If you’re unfamiliar with the cycle of investor emotions, an attitude of despondency often reflects the point of maximum financial opportunity. Although we were not attempting to call a bottom, we were stressing the utmost importance of sticking to a process, remaining calm, and not making any decisions based on fear alone. 

Today, I’d like to follow up on this narrative with more focus and detail on our investment management process and the importance of remaining deliberate with this process in preparation for and during the most difficult market conditions.

To be clear, before we invest the first dollar for our clients, we always first develop a strong knowledge and understanding of their full financial picture, including cashflow, balance sheets, liquidity needs, goals, and timeline just to name a few, creating a truly customized process for every Ballast client. We believe that building the optimal investment portfolio must begin with setting clearly defined goals along with determining the appropriate amount of risk necessary to make those goals achievable. 

Once we fully understand your situation and goals, our investment management process can begin. Our objective is to maximize your investment returns within the context of your financial goals while working within your stated risk tolerance. In order to achieve this objective, we are focused on the following:

·      Asset Allocation – the decision of how to weight stocks, bonds and cash in a portfolio seems very basic but is a critical first step in portfolio construction. Conservative investors almost always want to own more in bonds and cash due to lower volatility, but these assets may not provide enough return to meet their goals. For aggressive investors seeking higher rates of return, can they stomach the potential large swings in value over shorter periods? This pillar of portfolio construction highlights the importance of preparation and planning on the front end and knowing our client’s goals and risk tolerance before building out a portfolio. We use modeling software to detail the future implications of different asset allocations on our client’s financial situation, and together we can agree on an optimal allocation. The chart below illustrates nicely what we all already know, a higher % of stock ownership leads to the potential for greater returns but also the possibility of larger negative returns.

·      Effective Diversification – all investments include varying levels and types of risk. By spreading our investments across asset classes and securities with low or no correlation, we can effectively lower our exposure to unsystematic (diversifiable) risk and volatility, providing an optimal risk vs. return profile. Risk management is at the core of our investment process and proper diversification plays a major role in decreasing portfolio risk thus enabling the potential to earn better risk-adjusted returns.

·      Tactical Adjustments – although we remain long-term focused, we do from time to time, make more dynamic, forward-looking changes based on market or economic trends we attempt to capitalize on. For example, recently we trimmed some of our fixed income positions that had seen rapid appreciation due to treasury yields plummeting and moved the proceeds into cash until we find an opportune re-entry point. These tactical decisions along with all of our investment decisions are made during our in-house (now zoom), at least monthly, investment committee meetings. This committee has deep expertise in navigating challenging market situations and is dedicated to conducting the research necessary to make sound investment decisions in an unemotional manner.

·      Security Selection – although asset allocation is likely the most impactful investment decision we make, choosing specific securities to build out the portfolio is still a key component and requires a great deal of research and debate. We make these decisions based on several factors including: investment performance, manager tenure, cost, tax efficiency, size, factor, liquidity, etc. Our portfolios are constructed using exchange-traded funds, mutual fund companies, institutional money managers, third-party asset managers and individual stocks and bonds.

·      Monitoring, Rebalancing, and Evaluation – this step of the process requires constant attention as risk exposures must be monitored to ensure our strategic asset allocation models not only remain in line with our targets but also that investment objectives are being achieved. We rebalance portfolios periodically and strategically given changes in market and economic conditions with tax efficiency always top of mind. We continuously evaluate the performance of our portfolios to ensure they remain on the efficient frontier, providing the optimal risk/return profile for our clients.

This clearly defined, repeatable process allows us to continuously make sound investment decisions for clients not based on emotion, but on research and well thought out strategies. I’ve been asked several times over the last six weeks if our clients are panicking during these extremely difficult times. To their surprise, my answer has been a resounding no. I think a lot of my answer points to how knowledgeable our clients are in understanding that this market sell-off will rebound given time. However, I also believe a big part of it is that our clients understand how well we know each one of their situations. They know we have built these type of black swan scenarios into their individual financial plans and they know we have the proper processes in place to continue to make the best decisions for them no matter the chaos.