Allocation Risk Budgeting for Equities
By Jeffrey Dunham, Financial Advisor | Volume 2, Issue 3 (March 2014)
This is the final installment of The End of the Great Migration into BondsSM article series. In January, we began the series with a discussion about a turnkey marketing campaign that provides FINRA-reviewed sales and marketing tools designed to allow financial advisors to focus on the vast amount of assets currently held in bonds. Last month, we examined “Allocation Risk Budgeting for Income”, which is a way to show your prospects and referrals how you might manage the risk they are taking within their fixed income portfolios. This month we will examine Allocation Risk Budgeting for Equities. As The End of the Great Migration into BondsSM continues, we recognize that some of the assets that are currently in bonds came from the equity market as fearful investors sought lower volatility than their stock portfolios offered in 2008 and 2009. As these investors examine the prospects of re-entering the equity markets, they may be seeking a financial advisor who has a clearly defined process of managing stock portfolio risk. As the name implies, “Allocation Risk Budgeting” borrows from the familiar concept of household budgeting for income and the level of expenditures you can afford. Allocation Risk Budgeting is the process by which a financial advisor sets a plan for how much return and risk their clients are willing to take on their long-term growth investments. Recognizing that you cannot eliminate risk from growth investing, Allocation Risk Budgeting for Equities puts low correlated diversification at the heart of the overall growth investment process. It employs what we refer to as a “sleeve” of low correlated asset classes in an attempt to manage the risk in a growth portfolio. This “sleeve” is used in much the same way a “sleeve” of fixed income investments might be inserted into a diversified portfolio to reduce risk. As with the “sleeve” of fixed income assets, the size of the alternative sleeve depends on how much risk your client is willing to take or “budget” within their portfolio. Clearly, constructing this sleeve requires the inclusion of asset classes that exhibit low-correlated returns and volatility characteristics when compared to the classic equity asset classes held in the portfolio. It appears to us that the earliest attempt to achieve this type of diversification was accomplished by inserting one low correlated asset class or style of investing. These took the shape of investments like a long/short portfolio, commodities funds or a managed futures fund, as opposed to a sleeve of various alternative investments. The fallacy here is evident as this would be akin to having only long-term government bonds in the bond portion of an allocated portfolio. Market history suggests that correlations are not stable or always predictable, and that a single alternative investment does not produce alpha on a consistent basis. In our quest to find the best combination of alternative investments, Dunham & Associates’ Analyst team divided the market into three segments:
- Up markets;
- Down markets; and
- Flat markets.
They then looked at a variety of asset classes and investment styles and determined what they considered to be the best mix of alternative investments for this sleeve. You can view the results of this study by clicking on the link below. Allocation Risk Budgeting for Equity Overview
Important Disclosures: The End of the Great Migration into BondsSM is a Dunham & Associates FINRA-reviewed marketing campaign. Dunham & Associates is not responsible for its approval or use with clients. All materials comprised in this campaign must be reviewed by a Financial Advisor’s compliance department prior to custom branding or use. This document is provided for informational purposes only by Dunham & Associates Investment Counsel, Inc. solely in its capacity as a Registered Investment Adviser and should not be construed as individual investment advice. All examples are hypothetical and are for illustrative purposes. We encourage investors to seek personalized advice from qualified professionals regarding all personal finance issues. The solution for an investor depends on their and their family’s unique circumstances and objectives. Asset allocation, which is driven by complex mathematical models, should not be confused with the much simpler concept of diversification. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Rebalancing may be a taxable event.
For Financial Professional and Broker/Dealer use only. Not for use with the General Public.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA/SIPC.
ABOUT THE AUTHOR
Jeffrey A. Dunham is Founder, President and CEO of Dunham & Associates Investment Counsel, Inc., a wealth management firm based in San Diego, California. Mr. Dunham is also Chairman and CEO of Dunham Trust Company based in Reno, Nevada, and serves as a Trustee, Chairman, President, and Principal Executive Officer for the Dunham Funds. Mr. Dunham’s investment expertise spans over 30 years, including building a private client book of business with High Net Worth and Ultra High Net Worth clients. As an industry visionary, Mr. Dunham started what he believes is one of the only mutual fund families where 100% of its Sub-Advisers are paid based on their ability to outperform their stated benchmark. In Mr. Dunham’s view, performance-based Sub-Adviser compensation provides investors with a level of accountability that is as important today as when he founded the firm in 1985. Wanting to expand the concept of asset management accountability nationally, Mr. Dunham altered his business model to one that allows financial advisors to invest in Dunham Funds on behalf of their clients. Other innovations include creating a performance-fee based advisory wrap platform and a Nevada-based trust company that is designed specifically to work with financial advisors and their clients. In addition, Mr. Dunham has extensive experience in real estate investing and has managed private placement funds for investors. Mr. Dunham earned a B.S. degree in Business Administration with an emphasis in Finance from San Diego State University. He holds FINRA Series 3, 4, 7, 24, 53, and 63 registrations.