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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


  • My Value Prop in Context I like David Van Knapps 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:



  • My Value Prop in ContextMy value proposition vs. robos

    What is a robo? An algorithm? An interface? An investment platform? Its 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 CALSTERs Trap with endless policies: http://www.calstrs.com/general-information/list-investment-policies

    My approach is similar to Rick Ferriare we robos?


  • 5Rick Ferris 60/40

  • 6Rick Ferri: Comments on Vanguards New Robo


    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


  • 8Bayesian 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, Im bullish on stocks and risky assets.


  • 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


  • 11

    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

  • 12

    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

  • 13

    Sample UMA with Microcap Sleeve

    Contains stocks and target durajon ETFs for bonds.

    Could use bank CDs for bond ladder

    Source: Right Blend InvesLng

  • 14

    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

  • 15

    Some Decent Microcaps

    Ticker Name Last Rank Industry Sector Price MktCapUWN Nevada

  • 16

    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


  • 17

    Retirement: 6.4% Returns


  • 18

    Retirement: 4.4% Returns


  • 19

    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


  • Resources

    1. Expected Returns: Download RBIs 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://



  • DisclaimerAll written content is for information purposes only. Opinions expressed herein are solely those of Right Blend Investing and our editorial staff. Material presented is believed to be from reliable sources, however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation. The presence of this article shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services to any residents of any State other than the State of New Jersey or where otherwise legally permitted. This is not a complete discussion of the information needed to make a decision to open an account with Right Blend Investing, LLC. There are always risks in making investments, including the investment strategies described.

    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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