Rebalancing Period: 09/30/2014 to 12/31/2014
Primary Investment Themes
U.S. Value Stocks
U.S. Microcap Stocks
Emerging Mkt & High-Yield Corporate Credit
How We Arrive at our Investment Biases
The investment biases built into our model portfolios are driven by our forecasts of 10-year annualized returns and risk characteristics for the 30 asset classes that make up the Kivalia investment framework. While it sounds confusing, ours is a very systematic approach that attempts to capture today’s relative valuation disparities coming back into alignment over extended periods of time. Let’s walk through how we arrive at our specific forecasts.
For fixed income sectors, our 10-year annualized forecast returns are simply the current yield of the index that represents the sector. For the high-yield corporate bond sector, we make a small downward adjustment to capture the probable effects of defaults over the longer term. For mortgage backed securities we make a small upward adjustment to capture expected higher compounding of returns due to lower expected price fluctuations than other fixed income sectors.
For equity markets (including REITs), we compare valuation measures (such as price-earnings and price-to-cashflow ratios) relative to expected 10-year growth across sectors, and normalized versus our expectations for the overall market. Thus, at all times we’re biased towards sectors that are relatively “cheap” when both valuation and growth expectations are considered.
Generally, our equity sector biases can be described as a “mean reversion strategy” - one where differences in sector valuation per unit growth will revert back to (and perhaps through) the cross-sectional average over time. From a practical perspective our methods allow us to de-emphasize market timing and instead focus on longer-term valuation discrepancies.
Return expectations for Gold, Silver & Commodities are tricky, as these asset classes have no inherent return characteristics, such as yield or earnings. We currently derive our estimates for these sectors qualitatively based on the tenor of the economic landscape at any point in time. In periods where dis-inflationary/deflationary themes prevail, expected returns will be low relative to other sectors. During increasingly inflationary times, expected returns will be high relative to stocks and bonds.