Portfolio Construction Process
Our methods for investment selection and portfolio construction are based on a blend of lessons learned by our team through our different experiences over our years in the financial industry. We have a combined history of almost 75 Years in the investment industry including time spent as advisors and time spent working in the institutional space, understanding the process involved in selecting global pension managers to a mutual fund platform. Our Portfolio Building process at Armour Wealth has been refined from the combination of these multiple layers of experience.
In choosing which investment management firms and mutual fund companies to work with, we start by ensuring to identify any inherent bias that we might have. We truly are an independent firm, and as a result, our goal is to take an agnostic approach with respect to our investment selections. Our process drives the choices of investment managers as opposed to following any bias we may have to a particular mutual fund company. As a result, we recommend funds from major bank competitors, some of the leading third-party fund companies in the industry and some more niche and boutique options as well. None of our decisions are made on-the-basis of compensation and consideration is solely based on our process as outlined below. Some of the tools we use when sorting through the 30,000+ mutual funds available to investors in Canada are:
- Performance Metrics
- Volatility Metrics
- Manager Due-Diligence
- Ongoing Monitoring
- Watch List
- Sell Discipline
- Portfolio Construction
Category Selection: When building portfolios, we look at funds by category and we exclude certain categories from our analysis. We do not analyze stand-alone emerging markets, resources, or precious metals funds for instance. This is the first step in shrinking the overwhelming universe of funds available for real portfolio consideration. We use a tactical balanced core and build-upon it with a fixed income base and complementary equity and specialty equity positions.
Performance Metrics: We measure performance on a 5-year basis at minimum. We will consider the track record of a fund that has been brought to Canada recently but only if it has existed in the exact same format elsewhere, having at least a 5-year track record in the UK or U.S. for instance. We target funds that have a 3 and 5-year performance metric that is both above peer group average and above standard benchmark performance after-fees. This shrinks our focus universe down significantly.
Volatility Metrics: In-order-to take the next step in further narrowing our mutual fund prospects, we next look to volatility. We analyze standard deviation, Sortino ratios, and other risk metrics to look at the risk profiles of the funds still under consideration after the performance sorting. A key focus of our analysis hones-in on downside mitigation, and up/down capture ratios. We attempt to target funds which have a consistent track record of capturing most of the upside movement of a market, while avoiding a greater proportion of the downward movement. This is intended to provide a smoother growth profile over the short and mid-term and, targets the outpacing of the benchmark in the long-term. It also further shrinks our fund focus universe to a more manageable realm of funds across categories.
Manager Due Diligence: Having a narrow list at this point allows us to delve into a deeper understanding behind the process driving the management of the funds, the history of the managers on the funds, the make-up, breadth, and diversity of the teams etc. In doing so, we work with the fund companies directly to meet with and question their teams and their managers. We look for a simple, definable processes which a manager can easily communicate, and which an entire team can follow. We want their processes to have been consistent and in place through the history and track record of the mandate as well. We prefer management teams to individuals for consensus of decision-making, ongoing accountability among members, diversity of ideas and outlook, and continuity.
Ongoing Monitoring: We manage an open and ongoing communication with the teams at the fund companies we are actively holding, and with many which we are not currently holding. We follow manager commentaries and participate in manager webcasts while continuing to independently monitor the manager’s performance as well. We manage our independent analysis with ongoing reporting through use of analytical software like Morningstar, and Fundata, and with direct detail gathered from the fund competitors. Our list of focus funds as a result has been streamlined to around 25, with another 10-15 on watch for future potential.
Watch List: With respect to our list of focus funds, if there is a change in performance that seems outside of the normal parameters or significantly differs from market direction, we will put the fund on a watch-list and have direct interaction with the manager to understand why. It facilitates a deeper dive into the effect of a manager’s process in varying situations and allows us to ensure that we are in-the-loop on a regular and consistent basis as a manager’s process pans out, or not.
If the manager’s process remains unchanged then it may be maintained as a longer-term hold, if performance continues to lag through a whole cycle, then the process may no longer be as relevant as it once was, and we will likely remove the position.
Sell Discipline: If however, there is a change in process, a change in manager, or significant change within a team, we will address it immediately and the fund will no longer be considered as a valid choice within our portfolios. We will stop buying the fund for clients and will begin to actively move it out of existing portfolios. A significant change as outlined above essentially negates the validity of the former track record and its relation to the ongoing nature of the current fund. Essentially we consider the fund as having zero track record and as a result, it can no longer fit our criteria for inclusion in our clients’ portfolios.
Portfolio Construction: Our list of funds available acts as a toolkit that we will use to put portfolios together. Our focus is to build what we feel to be a complementary portfolio of individual positions. Though each fund may be good on its own, we want to ensure that it works cohesively and adds value to the portfolio as-a-whole. The portfolio should be built to a point where it is greater than the sum of its parts. To accomplish this successfully, we attempt to reduce overlap in management style within investment categories, particularly when combining funds within the same category in one portfolio.
We also look for funds that have a lower correlation to each other within the same category and we monitor individual holdings to reduce overlap. We used Morningstar as the key tool to help us better identify which funds were more likely to work well together in building our original Armour Model Portfolios. We have built portfolio models for our clients’ identified by risk profile (Conservative, Balanced Income, Balanced Growth, and Growth). We then removed and added-back each fund on our list one at a time by category, and analyzed the changes effected to the portfolio with respect to overall return and volatility.
The investments selected and used in our clients’ portfolios, are also held and supported by our team in our own portfolios. We eat what we cook. This process provides additional value to the financial-planning focus of our business and is a tried and tested mechanism for reducing risk at the portfolio level.