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How Does Your Money Manager Choose?: Evaluating Your Asset Allocations

Take out A piece of paper and draw a circle on it. This circle represents all of the significant public companies traded on the New York Stock Exchange.

Now draw a horizontal line through the middle of it

The upper half of the circle represents 100% of the largest companies in the total market. The bottom half of the circle is all of the smallest companies.

These two categories are determined by multiplying their daily market price times the number of shares outstanding. This is called the capitalization value.

If you had invested one dollar in the whole circle 90 years ago, it would be worth about $6000 today.

Now if you put one dollar just in the upper half of the circle it grew to about $4000 while the same dollar in the lower half of the circle would be worth about $25,000.

Clearly, the small companies have outperformed the larger companies over this 90 year period.

The evidence shows that over 57% of the time the bottom half of the circle will beat the top half of the circle in any 12 month period.

That’s January to January 1926 and then February to February 1926 looking at 1045 rolling one year period.

But if you look at 5 year rolling periods, January to January 1926 to January 1927, the percentage jumps to 64% of the time. In any 10 year period, the probability increases to 72% and over a 15 year period to 82%.

In other words, the longer you go out, the higher the probability small will beat large.

Now let’s draw a line vertical through the center of the circle.

This represents the liquidation or book value of a company.

Companies who have a lot of assets are on the right side of this line. And companies with a lower ratio of assets to market value are on the left side of that line.

You can see we have 4 quadrants or pie slices – large and small, value and growth. We call these submarkets.

The scientific evidence shows that the difference in performance for each of these four slices is statistically significant. The results are persistent, pervasive and robust. Let’s look at how $1 did in each slice.

We saw the whole circle did nearly $6000 over the last 90 year period.

How do you think $1 did in each pie slice?

If we look at the upper left-hand corner, $1 grew to nearly $3000. In the lower left, the small cap growth slice, $1 grew to $2200. This half grew at a rate less than the whole circle.

You have large-cap value in the upper right hand corner.

This slice grew to $11,000 over the 90 year period.

What do you think happened in the remaining slice, the small cap value?

Yes, much larger. Almost no one guesses $83,000.

This is over a 13% return, year in and year out for 90 years.

So the market as a whole has grown at a 9.8% to 10% rate, But the submarket have done much different depending upon which slice you are in.

If you were going to invest in the circle, which slices makes more sense – the right side of the circle or the left side?

The problem is that there is more risk with the right side. Investing is balance volatility with return.

But, obviously, it does make more sense to allocate based on our knowledge of the submarkets?

So what is the best way to allocate?

Do you think putting 25% in each slice makes the most sense, or should we allocated more to the slices that have done better over time?

We developed a mathematical algorithm to determine the best combination of these 5 categories – the whole circle and each of the 4 slices.

We call it the Efficient Frontier.

We can measure the percentage of your portfolio that should go into each of those five categories to optimize your return and minimize your risk.

So if you were to have invested in the whole market, it would’ve grown to $6000.

If you used our methodology finding the efficient frontier, what do you think your $1 would’ve grown to over that same period of time?

Our methodology would have grown to more than 4 times greater.

Your $1 would be worth $25,000. 

The total market went from $6000 using our algorithm to find the efficient frontier.

This is the same market, with the same stocks, over the same time period, with the same risk. Nothing changed except the way we allocated based on taking advantage of the research.

That’s what you pay us to do.

You pay us to find the most optimum combination of these five different categories or submarkets.

Our job is to find the efficient frontier and then keep you on it over your entire investment time horizon.

Let me tell you how complicated this is.

Assume we allocate in 5% increments. You could put 100% of your portfolio in any one of the 5 categories.

Or, you could put 95% in one category and then 5% in one of the other categories.

Or you could do 90%, 5% and 5%, or 85% and 5%, 5%, 5% or whatever combination you wanted to come up with.

If we do the math, there are 3125 combinations using those five categories.

Which one is the BEST?

Which one will give you the optimum return for the minimum of risk?

Only one of them is optimum. But which one?

Our algorithm tells us which one and that’s the one that went to $25,000 over the last 90 years.

Your portfolio is one of the 3125 combinations.

We have a method for deconstructing your portfolio and examining where you are on the efficient frontier. I can tell you from our experience, almost NO ONE is on the efficient frontier.

Why?

Because it is difficult to find and it takes a lot of work to do it. Our goal is to help all of our clients find the optimum allocation for their level of risk and then keep them on the allocation.

If you would like to see if your portfolio is on the Efficient Frontier, please give me a recent copy of your investment portfolio and we will deconstruct your portfolio and tell you exactly where you are on the efficient frontier and what you have to do to move from where you are to where you need to be.

Does that sound interesting to you?

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