Rockwood Capital Advisors, in conjunction with our sub-advisory partners, has developed an Outsourced Chief Investment Officer (OCIO) model. The OCIO approach allows institutional investors to more effectively and efficiently manage their day-to-day fund operations, helping them to better achieve their investment goals. This evolution away from the more “traditional” advisor/consultant relationship has developed and flourished as a result of the difficulties many plan sponsors experienced during, and immediately following, the 2008 credit crisis.
THREE PRIMARY REASONS WHY THE “TRADITIONAL” MODEL FAILED PLAN SPONSORS:
- Lack of Research and Resources
- Lack of TIMELY decisions and fiduciary oversight.
- Inappropriate investment modeling.
Most plan sponsors lack the internal resources, including historical research and investment expertise, to effectively establish, manage and oversee an investment plan capable of achieving their stated goals. Additionally, most plan sponsors are slow to act. In most cases it is not for a lack of desire but more likely due to a flaw in plan design. With many boards meeting only quarterly, it has become increasingly difficult to fulfill their fiduciary duties due to factors such as uncertain Federal Reserve policy, increasing market volatility, high frequency trading and international financial market shocks.
Asset allocation remains the key to superior investment returns over the long-term. Inappropriate modeling, “chasing” returns (asset classes and/or managers) and cost inefficiencies (particularly within the actively managed equity space) have all contributed to the difficulties plans have encountered in their quest to beat the market, particularly in recent years.
With Rockwood’s guidance, your plan’s roadmap to success will be driven by fact-based solutions in the areas of:
A 1986 study1 on determinants of portfolio performance found that 94% of a portfolio’s return is due to asset class selection and not security/manager selection or market timing. In other words, portfolio returns are determined almost entirely by how the “pie is divided” between stocks and bonds, small-cap and large, domestic and international and so on, and NOT by the specific securities or companies a manager may choose to invest in. So, variation in return is explained almost entirely by asset allocation. Market timing and security selection have minimal explanatory power (figure 2).
As fiduciaries we know that diversification and asset allocation, or asset class selection, have historically been major factors when it comes to the overall success of a plan. Diversification is essential, between asset classes and types, as well as across countries. Adding international equities is an effective way to improve portfolio diversification and returns, while reducing risk.
As part of an ever-expanding global marketplace, the U.S. currently represents approximately 52% of the world’s equity markets by capitalization, with developed international countries representing about 37% and emerging markets international roughly 11% (figure 1). While diversifying across countries, developed and emerging, is a great diversifier it also reduces overall portfolio risk. Additionally, company-specific risk can be easily minimized by holding mutual funds or ETF’s instead of individual stocks.
A basic tenet of investments is the trade-off between risk and return. According to the Fama-French Three Factor Equity Model (figure 3), historically, small stocks have outperformed large stocks by over 3% per year and value stocks have outperformed growth stocks by nearly 5% per year. So, tilting toward small and value can enhance return. Figure 4 below shows the annualized return and standard deviation, or risk, for each respective BAM* asset allocation mix for the last 15 years, beginning with a 100% equity portfolio. For comparison, the return and risk of the S&P 500 index is shown. While it is interesting to note that the return for each portfolio mix is ahead of the benchmark index, it is of particular note that the return of the BAM portfolio with just 20% in equities and 80% fixed income beat the S&P 500 annually over the 15 year period AND with 75% less risk! That is the power of asset allocation or asset class investing.
BAM- Buckingham Asset Management is a sub-adviser of Rockwood Capital Advisors
Fixed Income Management
In the context of a balanced portfolio, Fixed Income should be viewed as the foundation of the portfolio and the means of avoiding inordinate risk. Shorter maturity bonds, are less risky than longer term bonds and government or municipal bonds are less likely to default than corporate bonds, which contain equity-like risk. Depending on the size of the fixed income portfolio, individual bonds may be a more cost-effective way to own fixed income. It is also easier to manage the duration or interest-rate sensitivity of a portfolio with individual bonds. However, for smaller fixed income portfolios, we recommend the use of the DFA Bond Funds as the most cost-effective and prudent solution for your portfolio needs.
An example of a core/satellite portfolio containing recommendations for an extremely well diversified and efficient portfolio, is found in figure 5 below. The portfolio includes a diversified collection of U.S. and foreign equity, real estate and U.S. government and corporate, short and intermediate term fixed income funds. In each of the equity funds there is a tilt toward value and small-cap stocks, in line with our philosophy and the Fama-French fact-based research. The inclusion of real estate helps reduce risk in the portfolio and is often thought of as a fixed income substitute, particularly in times like these with very low interest rates. Additionally, with our process you will notice the broad diversification of issues, spreading your investments among approximately 12,400 issues globally – providing safety in numbers!