Building Dynamic Portfolios Searching the Globe Delivering Objective Strategies

INVESTMENT POLICY

Fund Architects offers every investor institutional-quality money management, including such time-tested strategies as strategic global diversification, dynamic allocations, high-quality active fund managers, and alternative or non-correlated strategies.

The Fund Architects Portfolios are managed and overseen by an investment committee that utilizes state-of-the-art analytic tools in building asset allocation targets and selecting high-quality funds.  They monitor the portfolios and return performance on a real-time basis.

STRATEGIC GLOBAL DIVERSIFICATION

Fund Architects is committed to taking full advantage of the power of global diversification for its clients. The US equity market amounts to less than 50% of the global equity market capitalization. Yet a recent IMF analysis of global capital flows estimates that typical U.S. investors have only 17% of assets invested outside the U.S., while in a true globally diversified portfolio that figure should be more than 50%.

At Fund Architects, we set our target asset allocations in line with the opportunities across the entire global financial markets. This means that our neutral equity allocations are globally diversified, with 60% in U.S. exposure and 40% to the rest of the world. During periods when global economic growth is expected to be stronger than that in the U.S., we will overweight international equity in order to take advantage of those growth and profit opportunities. Being on the right side of these historical trends will allow our investors to fully profit over the long term from the powerful trends of globalization and economic integration, rather than fall victim to them.

DYNAMIC ALLOCATIONS

Fund Architects manages portfolios for the long-term, but is always prepared to react to economic and market conditions in a timely fashion. Rebalancing to a well-diversified asset allocation leads us to automatically buy low and sell high. But at turning points in the economy and markets, we adjust our allocations and shorten our perspective, in order to reduce our client's risk and improve performance. In those market conditions we reduce our allocations to the most overvalued assets and overweight the relatively undervalued assets.

In order to identify extreme financial market conditions, Fund Architects looks at a variety of stock market valuation indicators to measure the relative values of international stocks vs. domestic, large-cap stocks vs. small and mid-cap stocks, and value stocks vs. growth stocks. We assess the bond market by looking at the interest rate cycle, current and historical interest rate spreads, currency market conditions, implied inflation forecasts, and default rates.

These relative stock and bond valuations are placed in the context of a broader perspective on global macroeconomic conditions. That economic analysis starts with the current consensus economic outlook and then adjusts that consensus data by looking at market reaction to economic data, historic economic cycle data, and expectations regarding current and future fiscal and monetary policy effects. While economic historical economic data and models are useful tools for understanding current economic conditions, it is crucial to understand that every economic cycle is unique and therefore qualitative expertise and intuition are vital in positioning portfolios for future economic conditions.

HIGH QUALITY FUND SELECTION

When selecting from a broad universe of managers, Fund Architects generally seeks active money managers who have a demonstrated ability to take advantage of market inefficiency through superior information, investment process, or intelligence. Typically, these managers have long-term track records of consistent, strong risk-adjusted performance.

It is crucial to understand when evaluating any active manager that their strategy and expertise typically works best in certain economic and market climates. As a manager of managers, it is Fund Architects role to understand each active manager’s strategy and role in the portfolio and to undertake dynamic manager selection by moving into and out of them as market conditions demand. For example, a deep value manager works best during a value market, and will typically significantly outperform a relative value manager. This means that it is important to understand the difference in their strategy and process when assessing their relative skills, and it is important to understand when in the economic and market cycle it is most profitable to invest with a deep value manager rather than a relative value manager. By effective dynamic manager selection, Fund Architects seeks to overweight managers when their strategy is in tune with market and economic conditions and capture their peak performance, and underweight or be out of them entirely when their strategy is out of favor. We use dynamic manager selection consistent with our views on dynamic asset allocation.

In some cases, dynamic manager selection may appear like Fund Architects is chasing the hottest performing managers. Rather, we monitor the best performing managers in real time to understand what current trends are driving financial markets. In cases, where those trends seem likely to persist, we may well move to participate in a manager's strong performance. However, that investment would always be in the context of identifying an underlying economic trend that is likely to persist and which will allow that hot manager to maintain their momentum.

It has been our experience that in many cases some of the best performing managers take advantage of flexibility to position their portfolios in the most attractive parts of the market. Fund Architects takes special effort to identify these managers and build them into our portfolios. We think this is an additional and often underutilized source of alpha. In many cases, this leads us to overweight managers who are identified as mid-cap managers, because they often have the broadest mandates to buy across all parts of the stock market. 

We use a series of quantitative scores and screens focusing on the following factors:

1. Manager tenure
2. Expenses
3. Performance consistency
4. Performance relative to market cycle
5. Pure Performance
6. Risk/adjusted performance
7. Correlation, and higher moments

We also assess each manager on a qualitative basis relying on the expertise of our investment team. Manager evaluations focus on analysis of three key factors:

1. The structure, stability and expertise of the management team.
2. The quantitative and qualitative process used for security selection.
3. The structure and characteristics of the managers' portfolios over time.

Once selected, it is anticipated that managers will be retained for at least a year. However, if there are changes in market conditions, investment process and portfolio, or manager team, the managers could be removed sooner.

ALTERNATIVE AND NON-CORRELATED STRATEGIES


Finally, we believe that every well-designed portfolio benefits from exposure to the most exotic asset classes and strategies, such as commodity-linked investments, currencies, and long-short strategies. These are investments that provide the best diversification and are the tools that sophisticated institutional investors use to control their risk and boost their returns. We believe all investors should take full advantage of such strategies.

According to recent IMF data pension funds typically have nearly 20% of assets in alternative strategies, up from 6% of assets a decade ago. The trend among other institutional investors, such as insurance companies and endowments has been similar. That trend has largely been driven by a search for alpha and the attractive risk-reducing effects of low correlation strategies and asset classes.

Commodity investing has been a clear example in recent years of the power of alternative investing. As energy and other commodity prices have risen sharply in recent years, they have clearly proven to be a valuable component in a portfolio. During periods when commodities have risen sharply, equity prices have been stagnant or falling. In 2006, Ibbotson Associates analyzed the role of commodities in strategic asset allocation models. They found that allocations of as much as 25% of assets to commodity indices added from 35 to 70 basis points to the expected return along the efficient frontier.

Unlike many of our competitors, Fund Architects has built our portfolios from their inception to include allocations to alternative investment strategies. Those target allocations range from 5% in the Growth portfolio to 35% in the Defensive portfolio.

Those strategies include a variety of mutual funds in which the managers follow investment processes that are similar to hedge funds, and have generated similar low-correlation performance, including long/short, merger arbitrage, convertible arbitrage, option income, global tactical allocation, and commodities.

INTEGRATED MANAGER SELECTION AND ASSET ALLOCATION

As we build our portfolios, we never forget that our managers must stand out on their own, and they must fit well together. If two of our managers have a similar investment process and holdings, then we do not attain the full benefits of diversification. In some cases, this leads to difficult tradeoffs, one manager may have a stronger performance record, but another manager may be a better fit within the overall portfolio. Making these tradeoffs is the real art of portfolio building, and requires intimate knowledge of both asset allocation and fund selection. Many firms separate these functions or rely on outside consultants to provide one of them. Our team is experienced in both and has been pioneers in the art of designing and building portfolios.

At the simplest level, integration of manager selection and asset allocation requires accounting for a manager's entire portfolio holdings in measuring how they fit into the asset allocation targets. For example, every manager holds some cash in their portfolio, which must be measured against the portfolio's cash target. Similarly, many domestic equity managers also hold some international equity. Finally, few managers are style pure. It is these basic realities of mutual fund investing that demand that portfolios be built by someone expert in both fund selection and asset allocation. Selecting and weighting a group of managers in order to hit asset allocation targets involves complex tradeoffs between the various asset allocation targets and the selection of the highest quality manager that are best made in an integrated fashion.