When it comes to picking investments to comprise a portfolio, what method makes the most sense? For some people, it is as simple as locating the investment products that have performed the best over the last few years and, if the fees are reasonable, simply selecting those products. All that person is doing is making their decisions by looking at what worked in the past. Taking this approach is often likened to driving your car by looking in the rearview mirror.
At Master’s, we take an academic approach to constructing our portfolios. We start with the understanding that, especially in the short-term, no one truly knows where the market is going next. As a result, we want to be sure that our models are exposed to many different areas of the market. Think of our model portfolios like an ice cube tray: when you fill an ice cube tray with water, you try to be sure that all the segments in the tray have water in them. We take the same approach with our portfolios: we want to be sure that we have exposure to many different areas of the market, as we can never truly know what area will outperform next.
Next, we apply a ‘tilt’ to the portfolios based on the academic data around what factors can lead to higher future expected returns. To continue with the word picture above, we tilt the ice cube tray slightly, such that more water collects in the areas of the tray that we want more exposure to. These factors are as follows:
- Profitability – We want more exposure to companies that make more money over those that make less
- Size – We want more exposure to companies that are smaller in size versus companies that are larger in size
- Price – We want more exposure to less expensive companies versus those that are more expensive
Through our internal Investment Review Committee, we work hard to make sure that our process stays in alignment with our convictions and goals for our clients’ portfolios. Our approach is one of looking through the windshield (what factors lead to higher expected future returns) instead of looking in the rearview mirror (judging on past performance).
What about you? How have you made your investment decisions in the past? We always love to hear from you!