Our expectation is for the plurality of investment returns to be a product of Investment Ideas, asset allocation, risk management and forecasting. We define marketing timing as the shifting of investments made in attempt to capture beneficial markets and avoid unfavorable markets. History suggests this process is far harder than it may seem. We do not seek market timing applications within this portfolio strategy. It is also policy to remain substantially invested over time.
The preponderance of investments selected are based upon an expected investment horizon commensurate with the programed Re-Optimization interval. In this way, we seek to maximize the performance gain by having disparate investment processes work together. Interim fluctuations should be viewed with appropriate perspective. Similarly, the Investor’s strategic asset allocation is based on this long-term perspective. Short-term liquidity requirements are anticipated to be minimal. The portfolio manager may seek to capture positional gains and use protective stop losses irrespective of anticipated time horizons.
Risk, by some measures may be associated with higher returns, this is referred to as compensated risk. Other risks may exist which do not bear any anticipated compensation. Please see the boxes below for a better understanding of what risks we are taking that are expected to bear compensation.
Risk that I am taking:
Risks that I am diversifying:
Risks that I am abstaining:
Risks that are being managed:
The financial planner, if applicable helps with the overall financial picture of the investor.
They are there to help the investor make the best decisions for maximizing any tax advantages
the investor may have available. Financial planners (a.k.a. Advisors) often also add value by
serving as a steady hand which can keep investors from making emotionally charged decisions
which usually create sub optimal outcomes. The financial planner may or may not be a fiduciary.
Some advisors get commissions from mutual funds, insurance product and annuities. Some planners
can be hired for fixed hourly rates to create investment plans. Advisors who have an ongoing
responsibility to monitor the strategy and provide advice and psychological support are usually
fiduciaries and charge a percentage of assets under management.
The investment manager is responsible for the execution of the strategy created by the IPS. It can be that the investment manager and financial planner are the same entity, but it is generally not recommended as the two skill sets and knowledge bases are sufficiently different. The investment manager is a fiduciary.
The broker is responsible for, accepting executing orders. It is often, but not necessarily y the same as the custodian bank. Brokers charge commissions but sometimes those costs are bundled with other custodian fees. Unless otherwise agreed, the commissions are paid by the investor. The broker is not a fiduciary but does have the responsibility to provide a best execution.
The custodian bank clears the trades and serves as the record keeper. All deposits and
withdrawals are made only to the custodian bank and never the other parties who do no handle
cash.
The Investor has retained an objective Financial Advisor (“Advisor”) to assist the Investor in
managing the overall investment process. The Advisor is a fiduciary and will be responsible for
managing a disciplined and rigorous investment process consisting of the following steps:
Alpha measures the return on an asset or portfolio that can be uniquely attributed to endogenous factors as opposed to market conditions. Alpha requires a benchmark to calculate. Alpha can be substituted for expected return values for the vector length function.
Asset allocation is simply the fraction of a portfolio held by various components. Current academic research suggests that the vast majority of portfolio performance can be explained by the asset allocation. With g-sphere, the asset allocation may consist of asset classes, specific securities or a combination of the two.
Beta is a statistical measure that measured the historical or expected price change in an investment given a change in another instrument. It is most common to use the Stand & Poor’s 500 as the reference index. A beta of 1.5 means that the measured investment has or is expected to advance 1.5% for every 1% advance in the S&P 500. Conversely a decrease in the S&P 500 of 1% has or is expected to result in a loss or 1.5% for the investment. Beta can be measured for individual investments as well as the entire portfolio. A higher or lower beta is not necessarily good or bad for a given investment, but a portfolio with an overall high beta could be riskier.
According to diversification optimization, cash is the origin of the model. Though it is labeled
as cash, it is an asset also functioning as a hurdle rate.
Cash is given the performance of the risk free rate. Assets must outperform the return on cash
to be considered in the efficient portfolio. Assets that do not meet this criterion are not
graphed. Cash is automatically added to any portfolio. This works because sometimes cash
holdings increase the diversification in a portfolio. In most well diversified portfolios, cash
will be dominated by other assets. When this happens, the model is essentially forecasting that
that for any possible movement in the market there is a combination of candidates that will
perform better than cash.
Correlation is the measure of the statistical relationship between any two events, observations or occurrences. When a positive incremental change in one asset statistic is always related to an equivalent positive change in the other, those statistics have a perfect positive correlation, or a correlation value of 1. On the other hand, when two assets have a perfect negative correlation (a correlation value of -1), a positive change in one is always related to an equivalent negative change in the other. Correlation values between 1 and -1 represent the spectrum of statistical correlation possible. A correlation value of zero indicates that there is no statistical relationship between the compared asset statistics. Most financial assets have positive correlation. Asset correlations between +.4 to -.4 are generally uncorrelated. Strong negative correlations are very elusive in traditional investment markets.
There are many types of portfolio diversification. Those quantifiable types may be reduced to
only two; systematic diversification and idiosyncratic diversification. Idiosyncratic
diversification is increased by simply holding more investments. Equally weighting the portfolio
is the approach which maximizes the portfolio’s idiosyncratic diversification. Idiosyncratic
diversification is typically easy to achieve.
Systematic diversification is typically harder to achieve. Systematic diversification is the
obverse of systematic risk. As financial assets tend to move up or down in unison greater
systematic risk is observed. In most market conditions intelligent diversification across asset
classes and within those asset classes will provide a substantial decrease to the systematic
risk. Gravity Investments invented a framework for measuring diversification in an integrated
framework that equates diversification to dimensionality. Higher dimension portfolios have more
diversification.
An exchange traded fund (ETF) is like a mutual fund but trades all day long like a stock. ETF’s are typically not actively managed but often provide a good tool set to capture exposure to desired market segments. ETF’s have ticker symbols add
An ETN trades all day long like a stock and is very similar to and ETN, but differs in that it is a debt instrument, often tied to the performance of a derivate contract. The ETN thus carries an additional risk based on the credit worthiness of the issuer.
The expected return is the measure of an assets return in the future. Though the g-sphere is flexible, the standard application is to use annual expected return values. We use the assets' historical return as a starting point; from this value, users are free to adjust the historical value to make an expected value. Generally, historical return values are not good prognosticators of future returns. We encourage a review of the historical values to ensure they become relevant forward-looking expected returns.
G-sphere allows for frequency selection of the input data. The effect of frequency changes affects the correlation matrix in that greater frequencies diminish noise that may be immaterial given the expected time horizon for the portfolio. Generally, greater frequencies will diminish the correlation provided that the assets have a positively skewed return distribution. Frequency selection should ensure that a significant number of observations are available for statistic creation. The number of observations is conventionally taken to be 20-30 minimum.
Holding period is used in the value at risk matrix. Each holding period counts one incremental observation frequency. Therefore, a 5 holding period can be measured in days or months depending on the sample data frequency.
Investment candidates are the total of all assets which are included for consideration within a portfolio. Diversification optimization works by accepting a list of assets or investment candidates. While all candidates are computed, only the efficient assets are included in the portfolio. Unallocated investment candidates are inefficient. You can generate investment candidates from any source.
The investment horizon is an important piece of the portfolio decision. The investment horizon determines how we look at the historical data to determine the results that are the most pertinent to use for setting future expectations. Two identical portfolios with different time horizons can have markedly different degrees of diversification. The investment horizons are also used for judging available portfolio liquidity and for tax planning.
The investment policy encircles the rules and purposes under which the capital will be managed. Investment policy decisions may or may not include asset allocation considerations. Commonly, fiduciaries who are not managers conduct asset allocation within the investment policy, even if further optimization occurs at their investment managers.
Investment strategies are tactical considerations that embody the application of information and knowledge to achieve superior market returns.
Liquidity references both the investor’s demands to take cash from the portfolio as well as the portfolios demands to trade with other market participants. Liquidity risk arises when market participants perceive great uncertainty and seek to sell investments across asset classes to park their money in cash or risk-free assets until more stable investment conditions return. Liquidity risk can be depicted as a contraction in the volume of the model.
The market value is the amount of money to invest. Market value is used to calculate share amounts for necessary for trades.
Diversification is the most effective mechanism to reduce market risk. Market risk is a value that measures the degree that the market or portfolio therein shares risk because of commonality between the asset in the market or portfolio.
This is the greatest percent decline from a previous high. In other words, an investor loses this percent if they make an investment at the worst possible time and exit the position at the market at the worst possible time.
The profit and loss (P&L) creates a hypothetical log of periodic portfolio values for each observation during the sample period. Each unique sample period is separated in its own P&L.
The assets expected annual rate of return on investment. This is also known as the average annual geometric return. This is the annual return before accounting for any compounding interest or returns. To calculate portfolio values in the future the geometric returns are compounded. Return data is always annualized unless otherwise labeled.
Risk adjusted returns are usually defined as the Sharpe ratio. A broader definition may also include a return values denominated by a risk measure without respect to the risk-free rate.
The risk-free rate is normally assumed to be short-term sovereign debt of the united states.
Therefore, the rate can be expressed as the yield on treasury bills.
Money market funds may also be appropriate. The diversification optimization uses risk free
assets as the origin. This can be cash holdings or any risk-free asset. It may be appropriate to
utilize a risk-free rate that accounts for return more than inflation. If the portfolio is
leveraged, it is appropriate to use the higher of the rate on borrowed funds or risk-free rate.
This represents an opportunity cost.
Systemic risk is also known as market risk. Using non-correlated assets efficiently reduced systemic risk.
Tactical asset allocations often are employed at the asset level and more discretion is applied to the input criteria in determining the allocation model. The array of investment candidates is dynamic depending on the manager’s expectations.
Gravity Investments is defining Portfolio Re-Optimization. We Enable investors and their advisers to create and automate custom portfolio solutions. The platform is Gsphere, an automated digital advice platform born from a legacy of objective diversification, advanced analytics and portfolio optimization. The core optimizer produces Diversification Weighted® strategies and can support and improve nearly any asset type or strategy. Diversification Optimization™ is embedded in an industry-leading rules engine containing sophisticated investment policy logic, that users can use to program most any strategy for optimization, back-testing and automation. Gravity’s thought leadership in the science of diversification enables financial institutions to build verifiably diversified portfolios and provides tools to educate investors about diversification and expose hidden risks. Gsphere’s 3D portfolio visualizations facilitate greater understanding, objectivity and make remarkable and compelling strategy recommendations. For more information please visit www.gsphere.net
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