Winning Investment Strategies Need Offense and Defense

Posted on: 07/18/2016


Scott Jones, Director of Business Development, iSectors

By Scott Jones

In the sports world, entire teams or individuals spend a portion of the time playing offense and another portion of the time playing defense. Good defense keeps bad things from happening while a good offensive strategy makes good things happen. Having a good offensive and defensive strategy is also important when it comes to being a successful investor. Do you, as an investor, focus most of your attention on playing offense, or defense? Or both?

I’m sure you’ve heard the saying that when it comes to successful investing, the key to winning is not to lose (money) or to at least try to minimize losses as much as possible. You might ask, is there such an investment strategy that successfully plays offense and defense simultaneously and how does it work?

The answer is “yes,” and it’s called the iSectors® Post-MPT strategies.    footballandinvesting2

These mathematically advanced strategies are able to play offense and defense simultaneously by capitalizing on the tremendous advancements in computer technology–which wasn’t available prior to 2005.  As a result of these advancements in computer technology, the iSectors management team was able to reinvent the traditional approach to asset allocation (based on the Nobel award-winning principles of Modern Portfolio Theory), and implement it using a 1950s algorithm called the Mean Variance Optimization (MVO) algorithm.

In the 1950s, the implementation of the principles of Modern Portfolio Theory using the mean variance algorithm was considered cutting edge. However, with advancements in technology since then, iSectors has developed a much more robust, objective, and mathematically advanced approach to applying the academically sound principles of Modern Portfolio Theory. This is why iSectors called these strategies Post-MPT strategies, which stands for Post-Modern Portfolio Theory.

What makes the iSectors® Post-MPT strategies a better approach to optimizing risk adjusted returns?

#1. These strategies utilize a better definition of risk (don’t go below zero), verses the traditional use of standard deviation (which is a measure of volatility). If volatility (standard deviation) is used to measure risk, it would imply that unexpected positive returns are equally as bad as unexpected losses. This assumption violates common sense and research in behavioral finance which tells us that investors are much more concerned with losing money than they are with making excessive returns.

#2. iSectors allocates these portfolio strategies to a universe of asset classes that have much lower correlation (or in other words, dissimilar) to one another than the traditional approach which dictates that you diversify among the following assets classes: large value, large growth, mid-cap value, mid-cap growth, small-cap value, small-cap growth asset classes. The problem with allocating a portfolio to these asset classes is that they have become too similar to each other and therefore don’t provide the benefits of diversification which is a tried and true common sense approach to reducing investment risk. Correlation is an integral component of diversification. Investors need to diversify among asset classes that have low correlation to one another (or in other words, truly different from one another) to reduce risk.

#3. Post-MPT Strategies utilize a much more robust asset algorithm that analyzes the changes in over a dozen objective capital & economic factors. The traditional approach to asset allocation uses a subjective mathematical algorithm called the Mean Variance Optimization (MVO). The problem with utilizing this algorithm is that it’s  flawed due to the fact that it relies on only three variables: volatility (standard deviation), expected return (a guess at best), and correlation (a measure of how similar investments are to each other). Along with the obvious problems associated with the use of these variables, it is also obvious that the economy, investment markets, and investment risk are all affected by more than these 3 variables. Therefore, asset allocation formulas need to be more robust and include the changes that are constantly occurring in many other, more relevant economic factors, such as inflation, interest rates, money supply, and unemployment.

#4, Post-MPT Strategies also help to reduce investment vehicle costs by only using index-based exchange traded funds instead of utilizing managed mutual funds. The reason for this is because managed mutual funds typically have a higher total fee structure (including pass-through capital gains taxes) that can be reduced or eliminated by using exchange traded funds to improve investor returns.

Overall, Post-Modern Portfolio Theory and research in Behavioral Finance have pointed the way to applications and technologies that can improve investment results and catapult the principles of MPT to a new level of usefulness. These improvements are what iSectors® Post-MPT Allocations take advantage of in order to improve the risk adjusted returns for investors.

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