After the technology bubble burst at the beginning of the last decade most investors became very familiar with style drift and a lack of diversification in their portfolios. “Back to fundamentals” became the mantra and everyone became a new disciple of diversification and asset allocation. Fund companies came out with asset allocation funds, fund of funds or even target-date funds. This was supposed to protect the investor from a repeat performance of 2000-2002. The problem is it didn’t work. 2008 taught us a portfolio with 7 to 10 asset classes was still susceptible to significant loss.
At Iron Logic, our investment strategy is based on the science of investing and lessons of the last ten years. It is rooted in years of academic research and institutional application. Our client’s main concerns of preserving wealth and mitigating taxes drive our investment strategy. Two academic research models drive our strategy for portfolio construction: Modern Portfolio Theory (MPT) and the Fama and French Three Factor Model (TFM).
Modern Portfolio Theory is a set of concepts aimed at building the most efficient collection of different types of assets based on the premise that investors want high returns but they dislike high risk. It suggests that assets should be assessed based on how they compare with an entire portfolio rather than in isolation. A portfolio of diversified investments is efficient if it yields the highest possible return for a given level of risk or incurs the lowest level of risk for a given amount of return. MPT was developed by economist Harry Markowitz in the early 1950 and won the Nobel Prize in 1990.
Fama and French’s Three Factor Model explains over 90% of a diversified portfolios returns. It is an expansion of the capital asset pricing model (CAPM) which explained 80% of a diversified portfolios returns. The model found that value stocks tend to outperform growth stocks; similarly, small cap stocks tend to outperform large cap stocks. The TFM has gained recognition over the years in portfolio management. Morningstar.com now classifies stocks and mutual funds based on these factors.
So what does this mean to you, the investor, as you try to navigate your way toward your vision of your ideal future? How does Iron Logic put the lessons of the last 10 years and this academic research to use? The portfolios we typically build address these lessons in four ways:
- We diversify portfolios in a much wider variety of asset classes. (MPT)
- We overweight value and small stocks in a portfolio when appropriate. (TFM)
- We minimize fees and transaction costs as much as possible.
- We mitigate taxes where possible in order to maximize our clients’ after-tax returns.
By embracing these theories and focusing on things we can control, the portfolios we construct for our clients are logical and comprehensive. We couple this with ongoing, disciplined monitoring to ensure the integrity of the portfolio is not compromised. This allows our clients to have confidence in their path to success. We deliver this strategy with relentless passion and sound judgement.
To see how we implement our strategy, please visit Our Process section of the website.