right blend investing - expected returns and the investment process
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Expected Returns and the Investment Process
December 11, 2015
Table of Contents
• 3-‐6: My value proposition vs. robo advisors • 17-‐12: My research priorities: I am now bearish for alts and bullish for microcaps
• 13-‐15: Portfolio construction: I am switching to models with ETFs and “sleeves”
• 16-‐19: Financial planning: My retirement simulations use lower returns
• 21-‐22: List of links
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My Value Prop in Context• I like David Van Knapp’s idea of core beliefs. This is practical, and avoids grandiose discussion of “philosophy.”
• I focus on expected returns, since these expectations drive everything an advisor does:
• Asset allocation, strategy selection, and financial planning. • I expect 10-‐year nominal returns of 6% on stocks and 2% on bonds with 2% inflation. Please see this link for details: http://seekingalpha.com/article/3606606-‐expected-‐returns-‐for-‐a-‐60-‐40-‐portfolio-‐a-‐simple-‐approach
• Autonomy for a portfolio manager is critical, especially when your assumptions change. This describes how autonomy drives my RIA:
https://www.linkedin.com/pulse/five-‐reasons-‐why-‐i-‐love-‐having-‐my-‐own-‐business-‐martorana-‐cfa?trk=prof-‐post
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My Value Prop in ContextMy value proposition vs. robos
• What is a robo? An algorithm? An interface? An investment platform? It’s blurry…
• Some robos are “algorithms on autopilot.” I believe that this is a violation of fiduciary duty.
• My value prop has robo technology: model portfolios designed to be scalable, using Unified Managed Accounts (UMAs) and “sleeves” of stocks.
• Advisors should not get too fancy, lest you fall into the “CALSTER’s Trap” with endless policies: http://www.calstrs.com/general-‐information/list-‐investment-‐policies
My approach is similar to Rick Ferri…are we robos?
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Rick Ferri’s 60/40
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Rick Ferri: Comments on Vanguard’s New Robo
Service
“Advisers take note: Vanguard is not going to change, so you need to change. Think creatively. Come up with ways to expand your practice. Start a robo, add services like comprehensive planning and wealth management, become a sub-‐adviser to other advisers. Do more.
Schwab has been pushing themselves on our clients for years and we survived. Most recently, the Schwab Intelligent Portfolio platform is being sold hard to every retail client that walks in a Schwab office nationwide. No problem. We innovate, we add value, we survive and thrive.”
Research Priorities
• Research bandwidth is always limited: Go where the returns are
• Use Bayesian process to make assumptions, test, and adapt
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Bayesian Process• Initial Assumptions
• My expected returns are 6% for SPY and 2% for AGG. This is simple and robust
• I believe that an occasional shift to cash is a powerful solution: It is better than using a third-‐party strategist, or an overlay for tactical asset allocation
• Updating the process • Bayesian thinking uses more than static rules, since market dynamics change.
• Investors must be “skilled in using new information to update their views.” Brett Steenbarger http://traderfeed.blogspot.com/2015/04/bayesian-‐and-‐static-‐reasoning-‐in.html
• Accountability • Clients need active advice, not autopilot solutions
Returns and Volatility
• Right now, expected returns are more important than volatility management.
• This will change as a recession approaches.
• Until then, I’m bullish on stocks and risky assets.
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Implications for Alts and Microcaps• I recently sold most of my liquid alts • Poor returns and transparency: VQT • Too hard to screen • Too much beta
• Cash diversifies better than alts: The tactical use of cash during recessions offers better transparency, better downside protection, lower costs, simpler hedging of tail risk, and virtually zero compliance and suitability risk.
• Microcaps return more than alts: But it requires active management in a core/satellite approach
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Microcaps in a Core/Satellite ApproachTraditional active management requires PM to have attractive ideas at all times in every:
• Asset class • Sector • Geography
ETFs + stock-‐picking allow opportunistic exposure… • When the asset class is attractive • When the stock selection strategy finds opportunities • Does not “force" the PM to buy
ETFs + micro-‐caps improves potential alpha and allows scale: • Allows PM to be “quick to sell and slow to buy” • Microcap models can be executed via a “sleeve” in a UMA…
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Microcaps Can Imitate Private EquityFinancial theory for PE replication: http://www.advisorperspectives.com/commentaries/osam_093014.php?
channel=General%20Advisory
Microcap stocks have: • Potential alpha due to illiquidity and neglect by analysts • Lower costs compared to venture capital • Higher transparency than VC and other private equity • A role in the portfolio as a “sleeve” in a UMA (Unified Managed Account). The microcap sleeve could hold an ETF in addition to stocks when opportunities are scarce.
• The integration of an ETF also provides a cushion for redemptions, and for changes in strategic asset allocation
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Sample UMA with Microcap Sleeve
• Contains stocks and target durajon ETFs for bonds.
• Could use bank CDs for bond ladder
Source: Right Blend InvesLng
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Portfolio123: “Decent” Stocks Below $10• Top half ranked by SMA(50)/SMA(200) relajve to industry/
sector • Top half ranked by sales and EPS growth over Q, TTM and 5-‐
years, as well as accelerajon •Avoid “Dumpster Fires”: Company must pass ONE of the
following: • Trailing 12 Month (TTM) EPS > 0 • A triple header:
TTM EPS > prior 12 month EPS, and Sales % Change TTM >0, and TTM FCF > 0
• Rank (Quality) > = 50 Rank considers Op Mar (TTM and 5-‐year), Asset Turnover, ROI and ROE (TTM and 5-‐year) and Finances (total debt/Capital, Int Covg, Curr Rajo)
Source: Marc Gerstein of www.PorNolio123.com
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Some “Decent” Microcaps
Ticker Name Last Rank Industry Sector Price MktCapUWN Nevada<Gold<&<Casinos<Inc. 1.81 99.56 Hotels,<Restaurants<&<LeisureConsumer<Discretionary 1.81 29.77INWK InnerWorkings<Inc 7.47 99.36 Commercial<Services<&<SuppliesIndustrials 7.47 393.58INUV Inuvo<Inc 2.94 99.1 Internet<Software<&<ServicesInformation<Technology 2.94 71.36KINS Kingstone<Companies<Inc 9.54 98.9 Insurance Financials 9.54 69.97PLAB Photronics<Inc 9.86 98.88 Semiconductors<&<Semiconductor<EquipmentInformation<Technology 9.86 655.76GSOL Global<Sources<Ltd 9.37 98.55 Internet<Software<&<ServicesInformation<Technology 9.37 280.22HTM U<S<Geothermal<Inc 0.59 98.44 Independent<Power<Producers<&<Energy<TradersUtilities 0.59 63.11JAKK JAKKS<Pacific<Inc 8.36 98.29 Leisure<Equipment<&<ProductsConsumer<Discretionary 8.36 169.37PLPM Planet<Payment<Inc 3.01 98.03 IT<Services Information<Technology 3.01 161.88NPTN NeoPhotonics<Corp 8.63 97.98 Semiconductors<&<Semiconductor<EquipmentInformation<Technology 8.63 346.45LIOX Lionbridge<Technologies<Inc 5.65 97.92 IT<Services Information<Technology 5.65 364.44MEET MeetMe<Inc 2.53 97.31 Internet<Software<&<ServicesInformation<Technology 2.53 115.02NNA Navios<Maritime<Acquisition<Corp3.6 96.9 Oil,<Gas<&<Consumable<FuelsEnergy 3.6 547.58NSSC NAPCO<Security<Technologies<Inc7.01 96.85 Electronic<Equipment,<Instruments<&<ComponentsInformation<Technology 7.01 132.95ULBI Ultralife<Corp 6.44 96.79 Electrical<Equipment Industrials 6.44 102.29
Source: Marc Gerstein of www.PorNolio123.com
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Financial Planning
• Nominal 10-‐Year Returns • 6% stocks + 4% bonds => 4.4% 60/40
• Volatility • 15% stocks + 4% bonds => 10.6% 60/40
• Critical Levers • Returns and asset classes • Distribution rates, flexibility, retirement age
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Retirement: 6.4% Returns
www.FlexibleRetirementPlanner.com
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Retirement: 4.4% Returns
www.FlexibleRetirementPlanner.com
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Financial Planning and Accountability
• Advisors must put their necks on the line regarding: • Low expected returns • Delayed retirement/working retmt • Flexible withdrawals/spending
• Robos dodge accountability • Passive investing is a fad, not a trend
Research Links1. Flexible retirement planner: http://
www.flexibleretirementplanner.com/wp/ 2. Bank CD Rates: http://www.interest.com/cd-‐rates/news/2-‐
year-‐cd-‐rates/ Note: These may replace target duration ETFs for bond exposure.
3. JP Morgan 2015 Capital Market Assumptions: Volatility on page 76. https://am.jpmorgan.com/gi/getdoc/1413614856458
4. kasina publications by Rob Martorana, November 2015 • “Liquid Alts in UMAs” • “Coping with Rising Regulatory Scrutiny on Alt Strategies”
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Resources
1. Expected Returns: Download RBI’s capital market assumptions (the PDF is a slide deck with links).
2. CALSTERs Investment Policy and Management Plan. 3. David Van Knapp on Investment Philosophy: http://
seekingalpha.com/article/3708416-‐can-‐you-‐define-‐your-‐investing-‐philosophy
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Right Blend Investing, LLC is a registered investment advisor in the state of New Jersey. There are always risks in making investments, including the possibility of
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