Q&A with MWA on Core+ Portfolios

Q&A: MWA CORE+ Portfolio Strategy or Investment Policy Questions surrounding the MWA CORE+ global Portfolios


Q: What’s MWA’s goal when building a prudent investment policy:


A: This is a question we spend a great deal of time discussing with clients.  I think the answer could be different depending on your specific stage of life and personal situation, but I think it is safe to say for a portion of your portfolio, what I’ll refer to as the CORE Portfolio, I believe the objective is to have the highest long-term risk adjusted rate of return, after taxes and net of implementation cost with the least chance of failing the objectives the client outlines in the investment policy or the goals the investment policy is constructed for in the financial plan.  As I’ve aged I wish I had been more conservative when I was younger and was told that was the time to take more risk because the reality is if you ever have a permanent loss of capital those dollars can never work for you again.  Losing money early in a career is detrimental because just think how much growth assets saved in your early 20s could grow to if they had been there to compound at 6-8%/year instead of trying to get more but losing it instead of earning a lower return.  Warren Buffet’s Rule #1 is to never lose money, and rule number 2: Never forget rule number 1.


Q: Why do MWA CORE+ Portfolios hold between 33-50% investments outside the US?   


A:US & International markets rise and fall at different times, so modern portfolio theory teaches that owning non-correlated assets improves portfolio returns.  A negative change to US economic policy can cause capital to flee US Markets in search of higher returns or better economic policies.  Therefore, diversifying across the globe is a prudent strategy that tends to reduce risk and protect against country specific problems.  Dissimilar market movements combined with rebalancing (selling the winners and buying the losers) will help produce higher investment returns especially if volatility is higher and money is added to portfolios systematically.  Because emerging markets and tilts to factors like small companies, undervalued companies, or high profit companies globally increases the number of companies owned and the expected risk, compared to just owning US investments only, having more securities and more securities that are perceived as riskier makes owning international assets offer portfolios higher expected returns over long-run market cycles.  Currently the US is 54% of the world market value as determined by the size of the world market.  Market size seems like a good starting place for determining the Investment Policy Weighting of a portfolio. 


Q: How did MWA arrive at 50% International weighting for its HI-Vol accumulator portfolios and 33% weighting for its LOW-Vol retiree portfolios?    


A: Retirees often need lower volatility than accumulators that are saving money.  Because retirees expenses are spent in US dollars not foreign currency, we tend to own a lower weighting to international investments for retirees because doing so reduces risk of needing the money while the market is down.  International diversification helps all investors, but if international markets don’t perform and a retiree needs the money before the markets rises, the retiree could be forced to sell while the market is down eating into principal or causing a retiree to approach 100% equity as other assets are spent.  That is why we typically have a 50% initial policy weighting for accumulators and a 33% initial weighting for retirees.  In portfolios that are withdrawing money, we need to have a smaller overseas allocation to lower volatility as compared to portfolios that expect to add money or just hold constant. 


Q: Why do we under-own growth stocks relative to the weighting in the S&P500?   

A: Because risk and return are related, we know that if we diversify and keep exposure to the 3 equity factors, smaller companies will eventually offer investors higher expected returns than larger companies. 



Q: Why do we under-own Utilities?   


A: Utilities are often seen as a defensive form of equity and are perceived as less risky than equities of non-regulated businesses.  Utilities typically have higher dividend yields and like REITs and resemble both equity and fixed income.  Research in portfolio construction has shown that it is possible to create safer higher expected return portfolios by combining negatively correlated high quality bonds with a broader array of higher volatility diversified global stocks covering the entire world with greater exposure to the 3 factors (undervalued companies, high profit companies and small companies) which offer higher expected returns than Utilities or REITs. 


Q: Why don’t we recommend dividend investing as opposed to total return investment:


A: Dividend investing offers lower returns than total return investing.  Dividend Investing captures about 60% of the value premium, but not all of it, so it is less efficient than total return strategy.


Q: Why do we use shorter-term high-quality fixed income?   


A: Because the yield curve is flat, investors are not being paid to lock up money for a long-time.  In this environment we believe it is better to take risk in equities not in bonds.  Bonds are our defense.  We want our bonds to rise when markets fall.  By avoiding low credit quality high yield bonds, the majority of our bond portfolios will rise if equity markets fall.



Q: What is the primary goal and secondary goals in the strategy we recommend


Long-term after-tax rates of return with the greatest chance of achieving the stated objective with the least possible long-term chance of failure.