- Risk and return are directly
related.
- A portfolio structured toward
large cap growth is a move to safety and lower
expected returns.
- A portfolio structured toward
small cap value is a move to risk and higher expected
returns.
- Freedom from brittle definitions, such as
the traditional consulting style box below, allows
precisely tuned portfolios.
- Investors maintain control
because degree of risk is a matter of preference.
Traditional Consulting Style
Box
-
Traditionally,
"products" have been classified into
rigid and sometimes arbitrary categories.
-
Style boxes force
crude strategic allocation.
The consulting style box displays
a size/style grid that is a traditional tool used
to identify asset class characteristics of portfolio
holdings.
The crosshair “map” offers
a more comprehensive analysis to pinpoint the degree
of size and value exposure in the portfolio. The map
plots the entire US equity universe in two dimensions,
with size on the vertical axis (large vs. small) and
BtM along the horizontal axis (growth vs. value).
All portfolios are plotted relative to the market,
which sits at the intersection of the crosshairs.
An investor seeking above-market
returns must take higher risks, which is achieved
by owning a greater-than-market proportion of small
cap and value stocks. The northeast quadrant offers
the target area for pursuing above-market portfolio
returns—and the farther northeast one travels,
the higher the small cap and value exposure.
All portfolios can be plotted on
the map according to their risk factor loading for
a given period in time. The resulting position reveals
much about their investment strategy—or lack
of one.
An efficient and cost-effective method
of implementing a portfolio designed to capture compensated
risk factors is to use passively-managed funds. The
use of actively-managed funds is not recommended because
they have holdings that vary more randomly across
risk dimensions, making portfolio structure difficult
to maintain.
Next: Markets
vs. Managers
