Q:  How has the fund evolved? A : The strategy started in September, 2008 with an initial investment from a large corporate defined benefit plan. While many people might consider this to be a poor time to launch a new fund it worked well for us – and our client – because it presented a very direct test of our investment approach. Our successful navigation of the crisis ultimately led to the strategy’s availability to retail investors starting in 2009. The aftermath of the financial crisis has led to some important adaptations. For example, we have enhanced our fixed income process over the years to address the risks to sovereign credit quality and the low level of interest rates. Q:  What is the objective of the fund? A : We want to provide a better balanced portfolio by trying to move away from what we thought were some of the limitations of traditional asset allocation techniques. In particular, we viewed mean-variance optimization as an extremely limited way of thinking about risk. The simple premise behind the product is that if we understand the main economic outcomes and target different asset classes through them, we might be in a position where we can better balance the portfolio to hedge against those different kinds of outcomes. Q:  Would you describe your asset allocation process? A : Our global asset allocation can be divided in two segments. The first of them would be the strategic allocation in the portfolio, the fulcrum point in the process, whereas the second layer to consider is how the tactical allocation process works. Regarding the strategic allocation process, we are primarily trying to focus on risk and correlation within and across the various asset classes. We will then figure out how to balance the risk within those different areas as well as determine how much risk we have across those areas. We have processes that estimate the risk contribution for each asset based on the weight and the average volatility of the asset and the correlation with all the other assets in the portfolio. By gaining access to that information, we can then look at balancing the risk contribution for the various assets. Our tactical allocation process is also global by necessity because the assets that we invest in are not U.S. centric. For example, in our equity allocation we have a third of the risk with assets from North America, a third of the risk from assets in Europe and a third of the assets from Asia. With six markets to represent different areas, we are then looking at each to determine whether we think that market will rise or fall relative to cash. If we think that both stocks and bonds are going to rise, we would like to increase our exposure to both. On the same notion, if we think the two asset classes are likely to fall, we want to reduce our exposure to both of them. When we make a determination of each asset relative to cash we look at three main factors and we apply a systematic approach to make these determinations. We look at factors like valuation, the economic environment and investor positioning. Also, we take a very classic approach to valuation for each of the assets. While for stocks we are using a discounted cash flow based approach, for bonds we are applying a Fisher hypothesis, and for commodities we are looking at supply and demand balance. Naturally, the economic environment will vary to a certain extent by asset. For example, within equities and bonds, we have to allow for some customization as we take into account the regional differences. One of the factors we use in equities assesses the risk of recession. We also think about factors that give us a sense for the broad financial market environment. Lastly, in the category of investor positioning we take a look at the price trends for the various assets. In particular, we are looking at price relative to the long term and short term moving average to help us understand whether price trends are rising or falling for each of the different assets. Q:  What research steps do you follow to evaluate ideas? A : We divide our research process into two phases – strategic and tactical allocation. For strategic allocation, we are trying to evaluate the structure of each of the asset classes to make sure that we can help those that are placed well in the portfolio. One of the important considerations has been the role of government bonds in the portfolio. We have instituted a process to ensure that we maintain the high quality of government bonds in the portfolio. Furthermore, we employ processes to evaluate the credit worthiness of each of the markets that we own, and if the credit worthiness starts to deteriorate, we actually reduce the strategic allocation to a particular bond market. That is an example of the kinds of research we do for each of the underlying assets as part of our strategic allocation. From a tactical point of view, the research is aimed at identifying what factors best help us understand whether assets are likely to rise or fall relative to cash. The fundamental part of our research happens on the front-end. We do a similar comprehensive review for the factors that we use in all of our systematic models for all of the assets in the portfolio. We will review the strategic allocation every month as we change our tactical allocation on a monthly basis too. When we receive inflows within the month, we will rebalance back to the target portfolio at the beginning of the month. In other words, we take the portfolio back to its target level at the beginning of the month. Then, at the turn of the month, we will reset the strategy to reflect on those current views. We apply the same framework to each asset within a particular complex and generally even within an asset class. For instance, for all the commodities we look at the same three sets of factors – supply and demand balance, the economic environment and investor positioning. Q:  How do you select assets? A : One of the underlying principles of our strategic allocation is that over the long term most assets tend to have similar risk-adjusted returns, which supports our notion of balancing how much risk we have from each of the asset classes. In the short term, risk-adjusted returns can vary quite substantially from one asset class to another as noted by our tactical allocation review. When we select what assets to use in the portfolio, we consider three major types of criteria. The first of them refers to what kind of diversification benefit we get and whether that meaningfully helps us improve our exposure to one of the possible economic outcomes. The second decisive factor is the likelihood of having long term excess returns. Finally, the last criterion for our consideration is liquidity. Our exposure to all of the assets is effectively currency hedged. We build those asset class exposures in a way that takes into account the role of that asset class in the portfolio. For example, in the fourth quarter of 2008, while we were going through the financial crisis, the yield of UK government bonds fell dramatically. Yet, at the same time, the pound sterling fell by 30% relative to the dollar, more than wiping out any gains from nominal yields. Q:  Are commodities a viable asset class in the portfolio? A : Yes. Commodities provide a hedge against unexpected inflation and tend to move independently of other asset classes. We also believe that commodities can provide attractive long-term returns. This belief has long been debated by academics and practioners alike. Yet the debate often focuses on common commodity indices which, in our view, are poor representations of the returns available to commodity investors. In effect, there are four key ways for investors to make money from commodities. The first is to focus on commodities that are scarce or difficult to store, the second is from rebalancing, the third is through optimal low yield, and the final way is the tactical allocation process. Our commodity investment process focuses on these areas without regard to the common benchmarks. Q:  Why do you exclude real estate in your portfolio? A : Even if we think about direct real estate as a nice hedge against the general rise in prices with long-term excess returns, we still have to concede that liquidity in the asset class is a serious problem. When it comes to real estate investment trusts, we find that REITs fall down in a couple of places. The first is that from a diversification perspective, over the last couple of decades, REITs have had a very high correlation with the S&P 500, so it is not clear that it really gives us much different exposure than equities do. The second area where REITs become a bit of a challenge is in the liquidity notion. While there are some ways to get exposure to REITs such as exchange-traded funds and other investment instruments, those could be a bit more expensive than the exposure to futures that we are able to achieve elsewhere. Therefore, we do not really see a meaningful benefit in gaining such exposure within this particular portfolio. We do recognize that REITs can play a nice role in complementing investors’ broader portfolios, but given our long-term goals, we do not see them as a necessary addition to our holdings. Q:  How do you build your portfolio? A : We are mostly concerned about three major economic outcomes: inflation, recession and non-inflationary growth. The ultimate goal of this approach is to provide total return with a low to moderate correlation to traditional financial market indices. Once we identify and determine what kinds of assets perform well in different environments, we get to the task of figuring out how to actually build a portfolio within each of those different environments while balancing risk that we are taking from each of them. For instance, in a traditional balanced portfolio of 60% stocks and 40% bonds, the biggest issue is that from a risk perspective the portfolio is not balanced at all. In fact, more than 90% of the risk comes from stocks as they are more volatile than bonds and have a greater weight in the portfolio. Rather than allowing the asset mix to drive the risk, we actually think of how to balance the risk first. Thus, when we build a portfolio we have one-third of the risk associated with assets in non-inflationary growth equities, a third of the assets for recessionary assets, which are long-term government bonds, and a third of the risk with commodities for inflation. When we put that all together we end up with a portfolio with about 60% in bonds, 20% in stocks and 20% in commodities. The hallmark of our portfolio construction process is our objective to target different kinds of economic outcomes with the help of tailoring a bespoke exposure to asset classes in order to balance how much risk we get from each asset class. Since we are not sure what kind of economic outlook is likely to prevail, we add on a tactical asset allocation process which allows us to make some tilts within the portfolio between various assets based on the highest probability of return. By reviewing individual asset relative to cash and adjusting our exposures, we can shift both the composition of risk in the portfolio and the total level of risk in the portfolio. The final result of this entire process is a long-only portfolio designed to win by avoiding substantial losses. Q:  How do you educate advisors about the merits of your methodology? A : We show our track record to certain advisors by breaking down the performance during particular parts of the recent economic cycle. What we emphasize is that during certain periods when equities have struggled we have tended to do quite better than our peers in preserving value. However, in periods when there are outsized equity returns we are likely to lag a bit. We try to avoid easy mistakes and big losses that just eat away from the returns in good times. Q:  What is your perception of risk and how do you manage it? A : Risk is a multi-dimensional phenomenon. As mentioned before, when we balance risk across different assets, we actually provide an insurance policy for various kinds of outcomes. Among other key factors for our consideration is the risk that an asset will no longer behave in its intended way. Government bonds are undoubtedly the best example with regard to that. In our ongoing research process we try to identify vulnerabilities so that we can come up with ways to mitigate them. A crucial aspect of this thorough analysis is the identification of risk that will not necessarily show up. Another type of risk that we are also cognizant of is associated with liquidity and our constant efforts to ensure that we can either put on positions or take off positions without any disruption in the market. In fact, our selection of markets to trade in is to a large extent driven by that consideration.