In our last issue of the Compass & Crosshairs, the underlying theoretical tenets of what we will refer to as the “Global Development Systems” method of investment portfolio management were discussed in some detail. The following assertions were made and topics discussed (See the July ’09 issue for further information):

1. Modern portfolio theory is correct, but incomplete
2. Gradualism and punctuated equilibrium: Our world is not a static one
3. The traditional application of MPT is stagnant and no longer applicable
4. Adaptation in portfolio management theory is necessary just to maintain the historical average rates of return and standard deviation of returns
5. Historical mean-variance optimization is insufficient- Forward looking capital market assumptions are required
6. An infinitely long term global historical perspective is required. Reliance on recent periods and domestic assumptions is deceiving.
7. Nationalism has no place in portfolio management
8. Overweighting to any one country, including the domestic one is a concentrated risk
9. Economic development is ultimately the underlying driver of portfolio returns
10. Emerging markets are fundamentally misunderstood
11. Political risk is in the eye of the beholder
12. Currency risk is significant and unappealing, but controllable
13. Back-tests confirm the theory
14. However, the historical back-tests are irrelevant - The future is where changes will occur
15. Ongoing and periodic philosophical reassessment

The structure of the portfolio management industry has been built to satisfy the requirements of traditional institutional-style MPT modeling, and consequently, it is not obvious how the ideas behind the Global Development Systems methodology can be applied, nor is it easy to apply them.

Therefore, pursuant to the prior theoretical conversation, in this issue, we will identify exactly how the GDS theoretical tenets can be applied to client portfolios on a practical basis, including the process of portfolio modeling, and methods of specific client account management. In addition, a discussion of the risk considerations associated with this new framework will be pursued.

The following discussion assumes that the reader has a prior knowledge of Modern Portfolio Theory, institutional-style asset management, asset allocation, or traditional portfolio management techniques:

Portfolio Modeling

Strategic Allocation Methodology

The GDS methodology utilizes a “strategic” asset allocation management style, and does so on a near-pure basis. This means that when a portfolio is initially constructed for an investor, the percentage split between cash, bonds, stocks, alternatives, and each of their sub-asset-classes will be fixed over time, and in general will not be actively manipulated in an attempt to create “alpha”. Instead, as the percentage splits between each holding of the portfolio changes over time due to cyclical changes in the markets, the portfolio manager will rebalance the portfolio back to its original allocation in order to ensure that the investor remains on track towards the achievement of his/her financial goals, and to ensure that clients are systematically addressing risk exposures.

An additional benefit to the portfolio manager is that strategic asset allocation is generally less sensitive to short term market fluctuations in terms of the need to actively shift the portfolio

Strategic allocation confers a number of benefits to the investor, including reduction of transactional costs in the portfolio and the reduction of the possibility of human error on the part of the portfolio manager eroding the portfolio value over time. An additional benefit to the portfolio manager is that strategic asset allocation is generally less sensitive to short term market fluctuations in terms of the need to actively shift the portfolio, meaning that more time can be spent in ensuring that client portfolios are appropriately adjusted to their long term needs and more time can be spent on ensuring a high degree of due diligence on sub-managers in the portfolio and the overall portfolio methodology. The strategic allocation is generally only changed over time to be more conservative as the client approaches the end of their investment time horizon, or when some other important factor changes in the client’s life and objectives for the portfolio.

While the overall allocation methodology is decidedly a “strategic” one, as opposed to a “tactical” one, elements of tactical asset management may be included. For instance, the portfolio manager may choose to tactically hedge or un-hedge the currency risk of the portfolio if he/she deems it appropriate for the client and has a strong expectation for a dominant secular currency trend. Another example would include the use of tactical/opportunistic purchasing of portfolio components. This is usually practiced when an investor does not have enough investable assets available at inception to purchase into a fully diversified portfolio, but wants to make regular systematic investments in the future. In this situation, it may prove beneficial to diversify the portfolio as much as possible from the outset, and then make any missing portfolio component purchases as the additional assets are added, purchasing whatever desired missing component shows the most depressed valuation at the time. This is sometimes referred to as “dollar value averaging”, a close cousin of the more common “dollar cost averaging”.

The primary difference between the strategic asset allocation methodology described above and the traditional strategic allocation methodology is that under Global Development Systems, the allocation is constructed with different underlying market assumptions, and is applied from a long term global development perspective, as opposed to a recent history US-centric perspective.

Forward-Looking Efficient Frontier Portfolio Optimization

While attention is paid to historical asset class correlations, asset allocations are not dependent on historical performance or averages. They are instead heavily focused on forward looking probabilities, a broad historical perspective, structural changes in economies, and macroeconomic secular trends. Future capital market assumptions are largely based on the fundamental long term drivers of investment performance: global economic development and human adaptation.

Whether an asset allocation modeler uses historical mean-variance optimization, forward-looking capital market assumptions, or Monte Carlo simulations to determine the appropriate split between asset classes and holdings, there is always a need to take a “bet” on what we believe the markets will do in the future. While it is either extremely difficult or impossible to consistently predict the future with any accuracy, it is generally considered best to reduce the risk of a portfolio by increasing the probability that the “bets” taken will come to fruition.

Historical mean-variance optimization makes the bet that the future will be just like the past was (and often looks only at the recent past). Monte Carlo simulations make bets that probability outcomes will fall within certain ranges and that the average of these outcomes will occur in the future (Often these ranges are also based on recent historical measures). Forward-looking mean variance optimization and/or Monte Carlo simulation optimization assumes a higher degree of uncertainty about the future, and that recent history may or may not be reflective of what is to come. It is this stance that is taken under Global Development Systems.

Parameters are based on a historical perspective that considers the entirety of human economic history

For portfolio optimization purposes, probability distribution curves for capital market assumptions are not assumed to be “normal”, but are instead adjusted for skewness, kurtosis, truncation, etc. Parameters are based on a historical perspective that considers the entirety of human economic history and non-linear long term projections of future economic experience. The “bets” that are taken under this modeling method (Bets are taken under all modeling methods) are based on assessing the probabilities for future growth potential, rather than linear projections of past performance.

Broad Range of Time Horizon Allocations

* GDS uses a much broader range of risk/return configurations than typically utilized in traditional asset allocation model series due to higher uncertainty assumptions and a longer-term perspective.

* Basic asset class splits are between Cash Markets, Fixed Income Markets, Equity Markets, and Alternative Markets.

* Capital Preservation models are generally composed of 100% individual fixed income securities held to maturity

* Distribution/Income models range from 3% Cash/67% Fixed Income/20% Equity/ 10% Alternatives to 0% Cash/ 35% Fixed Income/ 50% Equity/ 15% Alternatives

* Accumulation/Growth models range from 60% Fixed Income/ 28% Equity/ 12% Alternatives to 5% Fixed Income/ 80% Equities/ 15% Alternatives.

* Conservative models have a high percentage of low-risk sub-asset-classes, while Aggressive models have a high percentage of higher-risk sub-asset-classes. Ex: 25+ year time horizon accumulation model holds approximately 28% small cap stocks and 50% of the gross portfolio is in emerging markets equity.

Global Geographical Weighting Focus

* GDS assumes that the global economy is constantly undergoing structural development and that this can be capitalized upon

* Portfolio models specifically delineate between US Markets, International Developed Markets, and Emerging Markets

* The geographical weighting of securities is consistent with forward-looking probabilities for growth potential. Overweighting is given to economies with expected future above-global-trend growth.

* Generally heavily overweight emerging markets and international exposure relative to similar portfolios that utilize traditional US-Centric modeling.

Hedging the Risk of US Dollar Appreciation

* Portfolios may exhibit substantial currency risk if left un-hedged

* Foreign currency risk exposure is optimally 100% hedged, and currency trading may even be treated as a separate alternative asset class.

* A manager may choose to tactically hedge or un-hedge a portfolio’s currency risk depending on client objectives, or in rare cases, expectations for a dominant secular currency trend.

* Currency risk hedging is best accomplished through low cost vehicles (low purchase/carrying cost and low opportunity cost). This may include the use of currency futures contracts, but in most cases is better accomplished through the use of Exchange Traded Funds or mutual funds that offer leveraged US dollar exposure. This enables the portfolio to be “organically” rather than “actively/tactically” hedged and reduces costs that may otherwise eat into returns.

Segmented Style Box Methodology to Control Risk

* “Segmented style box” refers to the expansion and then subdivision of the traditional “style boxes” such as Large Cap, Mid Cap, Small Cap, Blend, Growth, and Value.

* The risk of each geographical allocation (Domestic, International Developed, and Emerging Markets) is further controlled by the subdivision of its own style boxes.

* Equity Market capitalizations subdivisions include Mega Cap, Large Cap, Mid Cap, Small Cap, Micro Cap, and Publicly Listed Private Equity.

* Equity investment manager styles are subdivided into Deep Value, Relative Value, Dividend Yielding, Blend Index, Active Blend, GARP (Growth at a Reasonable Price), and Aggressive Growth

* US Fixed income is split into CDs, TIPS, Treasuries, Agencies, Corporates, Actively Traded, High Yield, Floating Rate, Convertibles, and Municipals

* International Developed and Emerging Markets fixed income is split into Low Duration Bond, Intermediate/Long Term Bond, High Yield, and Inflation-Protected.

* “Alternative” asset classes are split into “Real Assets” (Global Commodities, Global Real Estate) and Hedging (Currency).

Pragmatic Security/Holding Selection

* Individual fixed income securities are used whenever possible, with any excess above lot size invested in ETFs or conservatively managed bond mutual funds/ SMAs (In most cases). Fixed income is typically laddered and held to maturity in order to increase the probability of return of nominal principal on these assets.

* The available equity managers and funds to fill out a Global Development Systems portfolio are limited by the structure of the industry, which is designed around traditional modeling. For example, in order to find an acceptable Emerging Markets Small Cap Deep Value manager, one might have to look across the universe of mutual funds, no-loads, ETFs, and SMAs (Separately Managed Accounts). Therefore, security selections are not limited to any specific investment vehicle, and may include all of these and more.

* “Best in class” open architecture manager selection is the optimal means by which to fill out the predetermined asset allocation in order to ensure that clients are receiving the best possible portfolio management for each component of the portfolio, and are not relegated to selecting from one or a few fund families or asset managers.

* The choice of use of an actively managed holding or passive index –based holding is predominantly based on expectations for net performance. The question is asked whether the performance of the holding is worth the cost of the management.

* Efficient vs. Inefficient Markets: In situations in which the net benefit of using an active manager is roughly equivalent to that of using a passive holding, a determination as to the “efficiency” of the market covered is made. In more efficient markets, passive managers are utilized, and in less efficient markets, active managers are utilized.

Separation of Taxable/Tax-Deferred Modeling, and Accumulation/Distribution modeling

* A total of 20 models utilized is generally appropriate (10 taxable, and 10 tax-deferred)

* Taxable models are constructed with attention to minimization of current tax liabilities through the use of municipal securities, low-turnover/ low distribution managers, tax loss harvesting, and tax transitioning from low-basis holdings in some cases.

* Tax-Deferred models are constructed with attention to performance-optimal security/manager selections, and the use of taxable bonds

* Within each Taxation-based 10 model series, there may be one capital preservation model, 4 distribution-phase models, and 5 accumulation phase models. Once an accumulation-phase client passes over to the distribution phase, the portfolio will be reallocated based on the appropriate distribution model.

* Time-Horizon-Based Accumulation: Accumulation portfolio modeling is primarily analytically-defined (as opposed to subjectively), and is time-horizon based. Time horizons are defined as the time expected to elapse before any distribution from the portfolio is expected to occur, either for the purposes of a lump sum or for income. Model time horizons are defined exponentially, and include 1-3 years, 3-7 years, 7-12 years, 12-25 years, and 25+ years.

* Target-Yield-Based Distribution: Distribution portfolio modeling is primarily analytically-defined (as opposed to subjectively), and is target-yield based. Target yields are defined as the percentage of income expected to be organically distributed (no sales necessary) from the portfolio on an annual basis. Model yield targets are determined by the expected average distributions of the sum of all underlying holdings, and defined as Low Yield, Mid Yield, Max Yield, and Supplementary Yield.

Special Considerations for Distribution Models

* Math of Distribution: Global Development Systems uses an approach that is specially tailored to perform well for distribution phase clientele (as opposed to accumulation phase). It makes modifications to the traditional methodology by using a set of mathematical rules that differ from those of accumulation modeling – the “new math” of distribution.

Target total portfolio yields are based on the average of the individual component manager dividend histories and expressed individual dividend targets.

* Target Yields Focus: Distribution portfolio building is focused heavily on yield/income. Individual asset allocation component managers are given the flexibility to determine when to make dividend distributions rather than using a total return approach based on selling holdings when assets are needed. Target total portfolio yields are based on the average of the individual component manager dividend histories and expressed individual dividend targets.

* Selectivity in asset/style selection: These portfolios are generally not style-agnostic, and will usually maintain over-weights to high yielding equity and fixed income.

* Opportunistic Income: Dividends, coupons, distributions, are generally routed to cash and then distributed either systematically or opportunistically, depending on the client’s needs.

* Non-Traditional/ Guaranteed products use: In addition to individual bonds, separate accounts, mutual funds, and ETFs, the GDS method may use products like annuities, structured notes, and other issuer-guaranteed products in order to limit market risk for distribution phase clientele.

Client Account Management

Decision Tree Investor Suitability Determination

* The Global Development Systems methodology makes use of a decision tree investor suitability questionnaire, rather than the more common traditional subjective risk tolerance questionnaires that assign grades to investor’s answers to questions and aggregate the grades for the purposes of determining an approximate appropriate allocation.

* The decision tree suitability determination results in more appropriate allocations for clients that are exactly matched to the client’s specific objectives.

* The decision tree method generally results in greater client satisfaction, but may also be more labor intensive for the advisor and the client.

* The GDS decision tree questionnaire may be included as part of a similarly-structured larger “Multi-Philosophy Investment” assessment tool.

Analytical Suitability Focus (Non-Subjective methodology)

* Questions posed on portfolio assessment questionnaires are primarily objectively/analytically-based, and not “feelings-based”. However, thorough explanations of the theory behind each selection is provided to ensure investors full understanding of how the information they provide will be used to generate an appropriate recommendation.

* Client subjective risk tolerance assessment (emotional ability to handle portfolio volatility) comes into play in the event that an analytical assessment results in a borderline decision on time horizon or target yield for a portfolio.

* This methodology is focused on developing a client’s full understanding of the investment philosophy to be applied in managing his/her portfolio rather than simply putting together a portfolio that they “can handle” subjectively, based on their risk tolerance. This results in greater client satisfaction in the management of their portfolio, as they are not solely reliant on the portfolio manager to simply do what is “right”, but instead are forced to understand why the portfolio manager is doing what they are doing. This results in less of a feeling of need on the part of the client to intervene and “keep an eye on” the portfolio manager, and ultimately leads to greater trust and client retention.

Brokerage or Fee-Based account appropriateness

* The Global Development Systems methodology can be applied in either a fee-based managed account structure, or through a transactional commission based brokerage account. Generally, the number of holdings (generally approximately twenty or more asset allocation components) will be too great to apply the method via direct funds (mutual funds custodied directly with the vendor) or disparate SMA managers.

* Fee-Based Account: Under the use of a fee-based or wrap account, in which the client will be charged a percentage fee for assets under management, the portfolio will likely be built through the use of No-load mutual funds, institutional share class mutual funds, load-waived A-share mutual funds, exchange traded funds, and individual fixed income securities in order to ensure cost-effective management of the portfolio for the client. This maximizes the alignment of the portfolio manager incentives with the goals of the client. Separately Managed Accounts will not be used in most cases, due to the generally small allocations to each component of the overall portfolio under the GDS method, and the high manager minimums that generally apply. Also, there are currently very few SMA managers in the emerging markets and international areas that have the highly specific mandates necessary for proper portfolio diversification under a GDS methodology.

* Brokerage Account: Under the use of a brokerage account, in which the client will be levied sales charges or transaction charges for each purchase made and/or trade placed, intermediate and long term portfolios (of three or more years, generally) are best suited to the use of A-share mutual funds, exchange traded funds, individual fixed income securities, and no-load mutual funds (where no appropriate ETF or A-share is available). C-Share mutual funds may be chosen for utilization for short-term accumulation phase clientele (generally three years or less time horizon) or for distribution phase clientele, depending on preference of the client and advisor. C-Shares may also be preferred for selected holdings that may be used only temporarily in anticipation of a future portfolio change, manager/holding substitution, or for short term tactical purposes (Including tactical currency hedging).

Adherence to Strategic Methodology

* As stated earlier, the Global Development Systems philosophy is derived from Modern Portfolio Theory’s Strategic Asset Allocation. Portfolio managers should emphasize the need to remain stoic in adherence to the strategic methodology with clients, and make portfolio shifts only in response to changes in investment time horizon, target yields, the client’s life situation, and investment objectives.

* Investors should not expect their portfolio manager under this scenario to proactively go to cash or other asset types when a financial/economic system correction or collapse is expected or occurring, or to attempt to manipulate the portfolio components in pursuit of short term returns.

Opportunistic Accumulation Portfolio Building

* Opportunistic portfolio component purchases are recommended for investable asset levels below the full-boat portfolio threshold. This can be accomplished in an intermediate or long-term accumulation portfolio (at least 3 years time horizon) that is experiencing regular systematic investments by opportunistically buying the portfolio position/component that appears to be most favorably priced or at the lowest point in its market cycle at the time of the systematic investment.

* Polarized first: In the absence of immediately available sufficient assets, all things being equal in a long-term portfolio, it is best to purchase the components with the most significant negative correlation first and then gradually fill in the portfolio with some of its core or higher-correlation components as time goes by in order to minimize interim portfolio volatility.

Fully Diversified Distribution Portfolio Building

* Distribution phase portfolios should, wherever possible, be fully and homogeneously diversified from the inception of the portfolio in order to dampen portfolio volatility to the fullest extent possible.

* In cases in which appropriate investable asset levels are not available, the focus in building the portfolio must be on providing the income from the portfolio’s core components, with the inclusion of satellite or non-core holdings to the extent that is feasible given the minimum investments applied by the individual holdings managers. The more volatility-dampening holdings that can be included while ensuring the provision of the necessary income, the better off the investor will be.

Periodic/Opportunistic Rebalancing

* Rebalancing of both Accumulation and Distribution portfolios should be performed periodically on at least an annual basis to ensure that portfolio risk levels remain appropriate for the client’s objectives. This will also ensure that the portfolio manager is systematically addressing risk exposures for the client over time.

* In addition to periodic rebalancing, portfolio managers must monitor portfolio allocations to ensure that they do not slide too far away from target ranges during the periods between regular rebalances. In the event of major market moves or significant shifts in allocation, a pre-emptive/opportunistic rebalance is recommended to further reduce risk.

Organic and/or Tactical Currency Hedging

* In most cases, and especially for distribution-phase clientele and short time horizon accumulation phase clientele, it is recommended that managers maintain an organic hedge to mitigate the risk of US dollar appreciation and its negative effect on non-dollar-denominated holdings. This can be relatively easily accomplished through the use of an ETF or mutual fund that provides exposure to the US Dollar on a leveraged basis, preferably of 2X leverage or more.

Such exposure minimizes the necessary capital allocation to the hedging position, freeing up assets to be used elsewhere in the portfolio.

The inclusion of such a position could be considered an “organic hedge” in that it does not require constant active manipulation to create the risk reduction sought.

* In some cases, especially those in which an accumulation phase client has an especially long investment time horizon of at least 12 years or more, a manager may choose to un-hedge a portfolio’s currency risk, or in rare cases, to tactically change the percentage hedged based on expectations for a secular currency trend.

Active Tax Management of Taxable Accounts

* Active tax management should be applied to currently taxable investment accounts. This may include the use of tax transitioning for new accounts with low cost basis holdings, and will include the use of annual tax loss harvesting at year-end, or preferably opportunistic tax loss harvesting when losses are experienced in an effort to increase after-tax performance for clientele.

Periodic Client Portfolio Reassessment

* Just as in the case of traditional Modern Portfolio Theory client management, it is necessary to regularly reassess the client’s life situation and investment objectives to ensure that the portfolio continues to be appropriate. By definition, an accumulation phase client’s investment time horizon will change on a constant basis. When portfolio model time horizon thresholds are passed, it becomes necessary to adjust the portfolio to the new situation. In addition to this expected change, unexpected changes in the client’s life may necessitate a wholesale portfolio reallocation in response to new objectives for the assets in question. A client portfolio reassessment should occur once every two years, at minimum.

Including Complimentary/Supplementary Theoretical Components

* The GDS methodology is primarily a strategic one, and not a tactical one. Thus there is no inherent ability to limit financial systemic risk, either in theory or in practice by utilization solely of the GDS methodology. To do so would require a tactical, opportunistic, or absolute return component to the overall portfolio. For clients that wish to attempt to pursue extra-market returns or to limit the systemic risk to their portfolio, the use of a tactical or absolute return manager is recommended as a complimentary investment philosophy to be implemented secondarily to the Global Development Systems portfolio on a stand-alone basis. This may be viewed as a separate portfolio maintained for the purposes of investment philosophy diversification.

* Income/Distribution models may be supplemented by a Conservative Tactical Manager or Capital Preservation Absolute Return mutual fund/ manager in addition to the base strategic portfolio in order to attempt to proactively limit financial systemic risk. The amount to be allocated to this non-strategic allocation component should be determined subjectively through conversations regarding investment philosophy with the client.

* Growth/accumulation models may be supplemented by the addition of a Conservative Tactical, Capital Preservation Absolute Return, or an Aggressive Tactical/Opportunistic mutual fund/ manager to attempt to limit financial systemic risk and/or achieve above-market returns. The amount to be allocated to this non-strategic allocation component should be determined subjectively and be treated as a separate stand-alone portfolio for performance assessment purposes.

* Optional in 12-25 Year accumulation models and strongly recommended at the 25+ Year time horizon is a portfolio methodology/component that we will refer to as a Long Term Human Development Probabilities Portfolio. A further in-depth discussion of this alternative investment philosophy will be provided in subsequent issues of the Compass & Crosshairs. This or another similarly themed concentrated thematic buy/hold component may provide an effective hedge against any potential underperformance of the GDS methodology for long term accumulation phase portfolios.

Risk Considerations Specific to GDS

Currency Risk: The relatively high allocations to foreign currency denominated assets in a Global Development Systems portfolio mean that investors in an un-hedged portfolio will experience greater volatility than might otherwise be the case if the portfolio were completely denominated in US dollars.

It is generally recommended that portfolio managers attempt to maintain 100% hedging of currency risk

However, this currency-based volatility can be mitigated or even eliminated through the use of hedging positions held in appropriate proportions to the currency risk undertaken.It is generally recommended that portfolio managers attempt to maintain 100% hedging of currency risk in order to gain exposures to the underlying economic growth of economies and security value appreciation that may accompany investment in those economies. If currency risk can be appropriately reduced or eliminated, the volatility of the overall portfolio will also be reduced. Returns will be comparable to a theoretical portfolio of foreign securities without exchange rate risk, denominated in US Dollars. However, for portfolios that remain un-hedged in terms of exchange rate risk, investors must be aware of probable increased portfolio volatility.

Political Risk: Substantial investments in concentrated positions exposed to the politics and institutions of any one country entail a high degree of political risk. This is true of foreign countries, as well as the domestic economy. The Global Development Systems methodology actually reduces political risk relative to traditional US-Centric modeling simply by virtue of the fact that greater diversification amongst myriad country and regional economies is present, as opposed to the concentration of the bulk of a portfolio in the domestic markets. Thus, political risk in a GDS portfolio can indeed be lower than normally possible, assuming the portfolio is sufficiently diversified. See the previous issue of the Compass & Crosshairs for a more in-depth explanation of political risks.

Limited Manager/Holding Selections: The structure and support for the investment management industry has predominantly been built for traditional Modern Portfolio Theory modeling. This means that the majority of available manager and security selections on most investment implementation platforms (and industry-wide) are geared towards US-Centric modeling. Therefore, there is currently a limited selection of managers and securities that a portfolio constructor may choose from in building a global development perspective portfolio. In some cases, it may prove necessary to use below-par or unproven managers to ensure full diversification, or alternatively, to use a proven manager to cover portfolio components that they may not usually be utilized for. For example, it may be necessary to use a good Emerging Markets Mid Cap Blend manager to cover a space that would optimally be covered by an Emerging Markets Mid Cap Aggressive Growth manager. The overlay portfolio manager must thus make practical decisions that may not be necessary under traditional US-Centric modeling. This adds an element of portfolio management difficulty and risk. However, as more mandate-specific managers become available and track records are created, exposure to this risk may diminish over time.

Systemic (Systematic) Risk: One of the fundamental problems with Modern Portfolio Theory in all of its forms (including traditional strategic asset allocation and the GDS methodology), is that it can neither in theory nor in practice reduce the risk associated with the broader financial/economic system. By definition, the theory states that “nonsystematic risk” may be diversified away, but that “systematic risk” will always remain. This systematic risk is that which is associated with global financial/economic factors that are not dependent on specific companies, industries, sectors, or geographies. The common factors that underlay all available investment options cannot be escaped in total by any methodology, especially one such as strategic asset allocation, which intentionally avoids the active shifting of portfolio components to capitalize on opportunities or to defend to the downside. Alternative philosophies do exist in the tactical, opportunistic, and absolute return worlds that actually attempt to limit systemic risks to investor portfolios and can achieve it, at least in theory. However, when it comes to the Global Development Systems methodology, investors must be made aware of the substantial pitfalls of systemic or “systematic” risk, which are generally not attended to.

Unproven methodology/ Philosophical Failure: A final remaining risk that investors must recognize is that the Global Development Systems method is not yet widely accepted by the academic/industry communities and that only a limited statistical track record exists. It is therefore possible that in the future the underlying theory, investment philosophy, and practical application thereof will prove to be a failure in its ability to provide superior risk-adjusted returns to the traditional modeling, or in its ability to achieve personal financial goals. That being said, this latter statement is also still true of the traditional modeling that has dominated portfolio management philosophy since the 1960’s. So for those who are willing to take a certain degree of risk as it applies to utilizing a new investment philosophy in order to capture potential superior performance and to seek a lower degree of future portfolio volatility than might be available otherwise, the Global Development Systems methodology is a valid option.

Conclusion

Although the risks relating to the use of the Global Development Systems method may be many, the same is true of the other available investment philosophies. The important decision lays in which risks we choose to take as investors and portfolio managers, as each investment philosophy will have risks that are specific to it alone. Global Development Systems is not a panacea, and can in no way account for all of the financial risks that face investors throughout their lives. However, when used by advisors under a broader comprehensive financial planning and Multi-Contingency Investing mandate, GDS can be an excellent core portfolio management tool for clients, or a strong satellite method to be used for investment philosophy diversification.