When we look at the world of investment management, we can break it down into 4 primary categories of investment method that can be used by an investor to attempt to achieve his or her goals. We’ve found through both proprietary and third party research that no single one of these methods is effective in all scenarios, but instead that each approach tends to have a particular market environment or part of the market cycle to which it is very well adapted. Our conclusion is that in order to achieve one’s life goals, one should diversify at the level of investment method, applying the most effective aspects of multiple completely divergent methods of investing, and not be dogmatic about using a single method.The broad categories of investment method can be seen as four pillars of a complete investment portfolio management methodology:
Characterized by investor fear and declining asset prices, a Bear market will be best attacked using Liability-Driven Investing.
Characterized by investor confidence and rising asset prices, a Bull market will be best attacked using Strategic Asset Allocation.
Characterized by investor uncertainty and volatile or sideways asset prices, a Wolf market will be best attacked using Opportunistic Investing.
Characterized by investor exuberance and soaring asset prices, an Eagle Market will be best attacked using Selective / Concentrated Investing.
We do not suggest that one attempt to predict which type of market environment is coming, but instead build a portfolio that may use multiple investment methods at the same time so that the overall portfolio is prepared for whatever contingency it may face. The question is: What methods should one use, when should one use them, and how much of each? The theoretical framework needed to answer this question is something we call Risk Premium Capital Allocation, which describes the optimal percentage allocation of an investor’s capital to various “Risk Premiums”. A “Risk Premium”, is the reward that can be captured by attacking a specific type of risk. The ability to capture different risk premiums is what we believe makes each of the 4 categories of investment management successful in their own respective Bear, Bull, Wolf, or Eagle market environment. We have identified four major risk premiums that may be capitalized on by investors:
These four risk premiums can be plotted on a chart to create an “efficient frontier” similar to the one used in Modern Portfolio Theory, that tells us the most optimal combination of risk premiums (and thus investment methods) for a range of investor objectives, and thus gives us our appropriate “Risk Premium Capital Allocation” (RPCA) for a given investor. The end result of creating and managing this multi-premium, multi-method approach is an aggregate investor portfolio that is better equipped to handle a much wider variety of market environments and contingencies. We believe that by doing the right investment planning and making practical investment decisions using the Risk Premium Capital Allocation theoretical framework we can help to increase the probability that an investor will achieve their financial goals.
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