TOPS® portfolio construction has 3 distinct phases:
Formulation of Strategic Asset Allocations, ETF Selection and Portfolio Monitoring and Management.
FORMULATION OF STRATEGIC ASSET ALLOCATIONS
PORTFOLIO MONITORING AND MANAGEMENT
A STRATEGIC APPROACH TO ACTIVE INDEXING™
A dynamic process of formulating strategic asset allocation targets and risk controlled ranges for each major asset class (Exhibit 2) is followed in TOPS® portfolio construction. As an example, an allocation to small and mid cap U.S. stocks for a portfolio might have a range of7-21%, with a current target allocation of 16%.
Through this disciplined formulation process, a 1-3 year prospective view on an asset class or ETF is taken before making any changes to target allocations. Potential portfolio adjustments are considered when asset class or market factor values are outside normal ranges in one of the many attributes monitored (such as valuation, yields, interest rates, earnings, inflation levels, etc). TOPS® defines values in the top or bottom 20% of their historical norms as outside normal ranges. (Exhibit 3).
Portfolio adjustments are also needed as markets naturally change over time. As a result, TOPS® portfolios are regularly rebalanced. Rebalancing is an important step in risk management in order to maintain portfolio exposures and minimize drift outside target allocation ranges. Finally, the process is designed with feedback loops in order to continually improve and evolve. The portfolio management team often describes the overall process as A Strategic Approach to Active Indexing™
As opposed to tactical or market timing investment philosophies, A Strategic Approach to Active Indexing™ typically leads to a lower magnitude and frequency of trading. However, a strategic approach often leads to a higher magnitude and frequency of trading than a static approach (Exhibit 4). Likewise, a goal of strategic investing is to generally lower total portfolio expenses and enhance longer term risk adjusted performance.
||Reduce Large Cap Growth exposure from 20% to 15%
||A few times per year
||Reduce Large Cap Growth exposure from 20% to 0%
||At least monthly
||Completely sell all equity exposure and swap into all bonds
||Weekly or more
Examples of A Strategic Approach to Active Indexing™ with TOPS®:
- Reduce exposure to an asset class due to historically high valuation metrics, and use proceeds to add to another asset class
- Adjust duration of fixed income portfolio due to a changing interest rate environment
- Swap ETFs due to particular exposure of underlying indexes, given the current market environment
TOPS® ETF SELECTION PROCESS
The TOPS® allocations are implemented primarily through the use of ETFs. The TOPS® ETF selection process relies on a combination of industry experience and resources available in the ETF community, along with institutional quality technology. The TOPS® ETF selection process is proprietary in nature; however, it includes the following important pieces:
- Relationships and consistent communications with some of the leading ETF providers and Portfolio Managers
- Use of multiple databases of ETF information
- Experience and tools in the area of ETF trading
THE TOPS® IMPLEMENTATION, MONITORING AND MANAGEMENT PROCESS