Do you know your advisor’s investment philosophy, strategy, and practices?

*This is the first of a multi-part series focused on investment philosophy, strategy, and practices*

In my role as Staff Economist at Alesco Advisors, I often analyze broad economic and market trends that investors have little control over. But I also serve as Portfolio Manager, which entails constructing and managing investment portfolios for our clients. This requires making decisions about things that are very much within our control as we seek to help institutions and families achieve their investment goals.

One of my responsibilities in this role involves transitioning new clients out of their existing portfolios and into custom solutions we construct based on Alesco’s investment philosophy, strategy, and practices. In doing so, I get to “look under the hood” of another advisor’s portfolio and learn more about the decisions they make.

In some cases, portfolios from other advisors reflect choices that are reasonable and defensible, even though I may disagree with a few of them. But in other instances, it can be nearly impossible to deduce a clear investment philosophy or consistent strategy being applied in practice. It’s these portfolios that have prompted me to pose the question in the title of this post and to share some important takeaways about investment philosophy, strategy, and practice.

Strategic Asset Allocation

Empirical evidence shows that a portfolio’s overall allocation among major asset classes—stocks, bonds, and cash— is the single most significant factor impacting levels of risk and returns for a long-term diversified investor[1]. Given the consequential nature of this choice, any reasonable investment philosophy, strategy, and practice ought to be firmly grounded in a properly structured asset allocation.

The overall mix of stocks, bonds, and cash should reflect the level of risk an investor is willing to take in pursuit of returns. Allocating too much or too little to one category or allowing asset class allocations to drift too far from target due to market fluctuations can change the risk profile and expected returns of a portfolio in ways that are inconsistent with an investor’s goals.

Within each of the asset class categories, every portfolio should reflect a clear strategy consistent with a cohesive investment philosophy. Owning various funds with strategic sounding names can sometimes masquerade as a strategy. But it can be the case that, when combined, the underlying fund holdings contain competing strategies or lack any semblance of a strategy altogether.

At Alesco, strategic asset allocation is the foundation of our investment approach. We listen to our clients and develop a deep understanding of their specific return expectations and tolerance for risk. We then combine this understanding with sophisticated empirical modeling to construct portfolios, selecting and combining asset classes to generate an optimized risk-return profile for each client. And the work doesn’t stop there—we actively monitor portfolios over time and make rebalancing adjustments when necessary to maintain each client’s allocation in disciplined pursuit of long-term investment outcomes.

Within asset class categories, our strategy entails emphasizing investments with shared characteristics known as factors. Research has shown that stocks of companies exhibiting certain factors—such as value pricing, small capitalization, and robust operating profitability—tend to deliver higher returns than the broad market over extended periods of time.[2] This evidence leads us to bias allocation toward investments with these factors within client portfolios.

Our allocation targets are designed to remain relatively stable in pursuit of long-term investment outcomes. But there are times when market pricing can dislocate from historical norms, which can create an opportunity to make changes that enhance portfolios. We closely monitor a variety of market data, including relative valuations, to identify unusual market conditions that may prompt us to make temporary adjustments.

Alesco employs this consistent philosophy and data-driven strategy within all our client portfolios. We believe the application of practices based on empirical evidence gives our clients the highest probability of meeting their goals given a wide variety of possible market environments in the future.

[1] Ibbotson, Roger G. (2010). "The Importance of Asset Allocation" Financial Analysts Journal, 66(2), pp. 18-20.

[2] Fama, Eugene F., and French, Kenneth R. (2015). “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 116(1), pp. 1-22.