Passive Funds – A mutual fund or exchange traded fund that seeks to replicate the movements of a particular index, like the S&P 500. They are generally low-cost and tax-efficient*.
Active Funds – A fund that uses the portfolio manager’s expertise to intentionally deviate from an index.
We customize fund selection based on client need or preference. We are advocates of using a mixture of both passive and active funds for portfolio construction. Passive funds work well in areas where fund managers generally do not beat their benchmarks net of fees. We tend to use index funds for domestic equity allocations, particularly large cap.
Foreign investing involves more variables than domestic investing. This includes varying GDPs, exchange rates, political strengths & weaknesses, geographic strengths & weaknesses, and different industry exposures. These increased variables create additional risks and opportunities for investors. Consequently, we believe that the ability to deviate from a benchmark can be beneficial in the long-run.
Most accounts will have some type of mutual fund component. Accounts that utilize individual stocks and bonds need mutual funds for specific sub asset class diversification**. We generally utilize a Core-Satellite approach for both equity and fixed income portfolios as shown below:
Our individual stock process allows for greater customization than can be achieved with a mutual fund portfolio. We focus on building diversified** large cap blend or equity income portfolios that function as the core piece of our Core-Satellite approach. Each individual stock portfolio can be customized to manage around concentrated positions, incorporate client social concerns, or tailored in other ways to help meet client-specific needs. Tax efficiency is maintained with a low turnover and capital gains management*.
Our research approach may be best described as top-down meets bottoms-up. We believe that a pure top-down approach does not adequately consider company specific factors. A pure bottoms-up approach may focus too much on company specific factors that often miss important macroeconomic data and trends resulting in missed investment opportunities. The excessive reliance on bottoms-up investing may result in falling for value traps when research focuses on company specific valuation metrics without properly understanding the reasons for those numbers. We believe that a pure bottoms-up approach, favored by many in the industry, tends to be too backward-looking.
Our research integrates both approaches to see which stocks are attractive from both perspectives. The top-down approach looks at the big picture in the economy on a global scale. We analyze the components of GDP, looking for both opportunities and risks. We consider major economic, financial, and technological trends to look for investing opportunities. Potential investments are identified from this top-down specific approach for more detailed analysis.
The bottoms-up approach is more quantitative in nature. A large universe of stocks is screened for several factors including: multiple valuation metrics, pricing trends, profit margins, earnings, dividends, and many other company specific factors. These metrics are also reviewed on a sector and industry basis to find relative attractiveness within each area or to assess overall sector and industry attractiveness. Interesting candidates from this screening process are compiled for closer examination.
We look for a correlation in the results of both approaches to assess attractive opportunities. There is not always sufficient overlap between both techniques, so we may occasionally value one approach over the other on a case by case basis. For example, we would not exclude a perceived bargain discovered from the bottoms-up approach simply because it was not attractive from a top-down approach. Similarly, a strong top-down discovery would not necessarily be excluded from consideration based on the bottoms-up view.
Tax-exempt municipals, corporates, treasuries, and agencies make up the Core Bond piece of our Core-Satellite approach to fixed income investing. The specific mix depends on account type and client tax situation. We analyze the yield curve, review inflation forecasts, look at credit spreads, and economic forecasts to determine our outlook on the fixed income markets. We then customize the investment selection based on client needs including, time horizon, ongoing income objectives, and short-term liquidity needs. We actively manage the overall duration and average credit quality of the portfolio depending on our outlook for the fixed income markets. Anticipated currency fluctuations will be considered for foreign bond exposure, which may consist of both developed countries and emerging markets.
The Core Bond component of the fixed income portfolio will be enhanced with additional sub asset classes like high yield, inflation linked, and foreign bonds. The relative attractiveness of these satellite allocations** can vary significantly in certain economic and market environments. Consequently, these allocations will use a tactical approach when warranted. Mutual funds that specialize in each of these different areas will be used rather than buying individual bonds for the fixed income satellite allocations.
Indices are unmanaged and investors cannot invest directly in an index.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
*Resonance Financial does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.
**Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.