It’s time to get those X’s and O’s organized into a strategic plan.
We all want to invest the same way the “Pros” do on Wall Street. Whether an investor client has $5000 or $500 million to invest, they all want the same thing; maximum return with an appropriate amount of risk associated with the expected return.
It’s easy to articulate, but not quite as easy to execute.
We have to keep score, so a comparative custom index of some sort will be our hurdle.
Unfortunately, that hurdle is difficult to clear on a consistent basis. Management fees, fund expenses, and transaction costs, team up to keep us from “leaping” high enough to clear the bar. However, with the right “equipment” we can greatly reduce those fee and expense “weights” and significantly increase our probability of beating the comparative index.
Diversification is the basic tenant that all institutional pros use as their investment foundation. Market capitalization and investment style are the most common building blocks of diversification.
We will “construct” a sample portfolio of top funds as our custom index benchmark, and compare that index performance to that of a “replicated” version of that index. (For illustration purposes, we will only use large cap funds for the time being).
However, once we have an “official’s time out” to review, we find a few problems.
Most of these funds carry an expense ratio of .80% on the low end to 1.20% on the high end, making it a problem to clear our index hurdle. Even if the expenses don’t slow us down, the minimum investment on some of these funds are in the $5 million to $10 million range. Throw in transaction expenses and we’re just adding insult to injury.
As investors we want access to this custom portfolio, but we don’t want the high fees and costs associated with it, not to mention the minimum asset levels.
We need a “franchise” player to make this work. His name is Portfolio Replication, and he brings an impressive game.
Let’s look at the results of a recent historical study showing the effects of Portfolio Replication on our custom fund index that we constructed using highly rated Large Cap Growth and Large Cap Value Funds. We will assume an even weighting among the funds for diversification.
The study period: 12/1/2009 – 11/30/2014 (5 Years)
Our custom fund index is a tremendous collection of large cap funds. Unfortunately, the minimum asset level required to buy that list of funds is out of reach for most investors.
Portfolio Replication, with a higher annualized returns AND lower risk levels wins the game. And with a very strong Alpha generation statistic, Portfolio Replication earns the MVP. Now investors of all sizes can own a championship team (portfolio) featuring an MVP play maker.