Beyond modern portfolio theory

Tactical asset allocation seems plausible and it does work -- sometimes.

Gail Bebee 7 August, 2015 | 5:00PM
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Do you know the asset-class mix of your fund-of-funds portfolio, and what's behind it?

Managed portfolios offered to individual investors are mostly constructed using modern portfolio theory, which was pioneered by Harry Markowitz, an economist whose resumé includes a Nobel Prize in economics. The theory proposes that for a given risk level (defined as variability in returns), poorly correlated asset classes can be combined to create an "efficient frontier" portfolio that optimizes the expected investment returns. Building such a portfolio involves determining the risk an investor will accept, selecting the optimum asset mix for this risk level, and researching and buying investments to achieve the chosen asset mix.

While modern portfolio theory is prevalent in the investment industry, not all money managers worship at the efficient-frontier altar. Among the non-believers is RiverFront Investment Group LLC, based in Richmond, Virginia, which employs a more active approach to portfolio construction that it calls dynamic investing. Within the investment industry, this type of discipline is commonly known as tactical asset allocation.

RiverFront's definition of risk is easy for investors to understand: the loss of money. Its tactical approach presumes that there is a strong inverse correlation between investment returns and the price paid for an asset relative to its historical trend.

Essentially, it's a risk-reduction discipline based on buying low and selling high. As the firm's chairman and chief investment officer Michael Jones explains: "Overvalued asset classes tend to fall further and faster than assets purchased at prices that already reflect a significant discount to historical averages."

RiverFront offers six portfolios that are tailored to address different time horizons and income and growth needs, and stress-tested to reduce the probability of loss. As asset values wax and wane, the portfolio mixes change as managers sell expensive assets and purchase cheap assets.

Exchange-traded funds lend themselves to this investing approach, and are the main holdings in RiverFront's portfolios. The firm also offers versions of these six portfolios that use ETFs only; two of these strategies -- Moderate Growth and Income, and Global Growth -- were added by CIBC Asset Management late last year to the offerings of its full-service brokerage affiliate CIBC Wood Gundy. (The ETF portfolios are denominated in U.S. dollars and require a US$50,000 minimum investment.)

Complementing RiverFront's mostly quantitative approach to portfolio building is manager discretion to make adjustments for risk-management reasons, or to take advantage of special opportunities. For example, the Global Growth strategy has a target of 100% equities, but the asset allocation could range down to 80% equities and 20% fixed income, depending on the portfolio manager's view of the markets.

So how do RiverFront's portfolio returns stack up to established benchmarks, and how well is the risk of loss minimized? A review of the track record of the six RiverFront strategies (not including the ETF-only versions) for periods ended May 31 reveals mixed results:

The most conservative strategy, called Dynamic Fixed Income, has a target asset allocation of 100% fixed income. (Note: there is no connection between RiverFront's "dynamic" strategies and the Dynamic family of mutual funds in Canada.)

RiverFront's fixed-income strategy returned 0.75% more than its benchmark, the Barclays U.S. Aggregate Bond Index, over the past three years, but 1.05% less since inception nearly four years ago. Over the past year, the return was -0.53% -- 3.5 percentage points less than the benchmark and clearly a miss in the risk-minimization department.

The next two strategies up the risk ladder, the Conservative Income Builder (target 30% U.S. equities and 70% U.S. fixed income) and Moderate Growth and Income (target 50% U.S. equities and 50% U.S. fixed income) have returned less than their benchmarks over all time periods. The benchmarks are blends of the S&P 500 and the Barclays U.S. Aggregate Bond indexes.

RiverFront's Dynamic Equity Income strategy has a target asset allocation of 70% global equities and 30% U.S. fixed income. The performance history is shorter than its stated seven- to 10-year horizon, but returns so far are promising. Since inception six years ago, it has delivered 0.83% above its hybrid benchmark, which blends the MSCI All Country World and Barclays U.S. Aggregate Bond indexes.

The riskiest strategies, Global Allocation (80% equities and 20% U.S. fixed income) and Global Growth (100% equities), exceeded the returns of their benchmarks by 0.08% and 0.34% over 10 years, and by 0.59% and 0.75% since inception over 11 years ago. The Global Allocation benchmark is a blend of the MSCI All Country World and Barclays U.S. Aggregate Bond indexes, and the Global Growth strategy is benchmarked solely against the MSCI All Country World.

Five of the six RiverFront strategies lost money in the years when their benchmark returns were negative. Some losses were worse than benchmark; others were better. The sixth strategy, the fixed-income one, recorded a positive return in 2013, a down year for fixed income, but lost money in 2014, when the benchmark posted a 5.97% return. The claim that "dynamic" investing minimizes investor loss appears questionable.

The newer ETF-only versions of the same six strategies have performed similarly to the original portfolios. Of note, the gross returns (before fees) of the Global Allocation and Global Growth strategies since inception nine years ago exceeded their benchmarks, but after advisory fees and investing expenses were deducted, the excess returns disappeared.

Like every other investment approach, tactical asset allocation works -- sometimes. As with so many funds, fees and expenses could erase all or more than the added value.

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About Author

Gail Bebee

Gail Bebee  Gail Bebee is an independent personal finance speaker, teacher and the author of No Hype--The Straight Goods on Investing Your Money. She can be reached at; her website is

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