Appropriate Utilization of Active Equity Strategies
- Frequently, we will perform portfolio analytics on a new client’s existing investment portfolio and discover a less than optimal structure.
- In this case, the individual’s portfolio was over-diversified across too many active managers within public equities, resulting in an expensive index fund-like exposure.
- We were able to reduce fees and improve tax efficiency by incorporating lower-cost passive or quasi-passive strategies.
- Further, we upgraded the portfolio by introducing fewer active managers with a sustainable edge or differentiated advantage, allowing the portfolio to deliver risk-adjusted excess returns.
Integrating Portfolio Management with Other Techniques
- Colony does not sell life insurance or otherwise accept compensation for recommending insurance products. However, life insurance can be a valuable tool to enhance portfolio construction with the right set of facts.
- In this case, we worked with an individual that had created a long-term dynasty trust before becoming a client of Colony.
- The trust owned significant portfolio assets and a $2.5 million term life insurance policy on the grantor’s life. We noticed that the policy had a contractual provision that allowed the trustee to elect to convert the policy to a permanent paid-up cash value policy with a single premium.
- We determined that the calculated IRRs on the premium and death benefit projections remained attractive each year through the individual’s actuarial life expectancy.
- After converting the term policy to a permanent policy, Colony proposed that the trustee consider shifting $2.5 million of the trust’s portfolio assets from fixed income to equities. The trustee agreed with Colony that the policy’s death benefit was, in effect, a $2.5 million hedge against the increased risk of shifting more of the portfolio to equities.
Active Asset Allocation and Opportunistic Rebalancing
- Colony’s investment approach is grounded in the belief that long-term, strategic asset allocation decisions matter the most. However, we also believe that an active, flexible approach can enhance returns by shifting capital to attractive risk/reward opportunities.
- We actively monitor ongoing market conditions and opportunistically rebalance portfolios in an attempt to take advantage of market volatility. We also seek to control risks due to drift from targeted asset class exposure, while improving after-tax returns by recognizing losses to offset capital gains.
- In our view, the extreme market volatility in 2020, brought on by the Covid-19 outbreak, created many opportunities to take action. For example, in early March as bond yields declined, we further reduced investment grade fixed income exposure to generate additional “dry powder.” Given the broad selloff across risk asset classes, we added to equity positions and real assets while implementing tax-loss harvest trades where possible. We also initiated an allocation to high yield credit given the significant widening in credit spreads. Further, as breakeven inflation rates (a measure of expected inflation) collapsed, we also initiated an allocation to Treasury Inflation-Protected Securities (TIPS) on weakness.
Full Transparency and Avoiding Conflicts of Interest
- A significant client had been working with a large, well-known broker/dealer and was sold several platform hedge fund investments that were laden with up-front loads and ongoing trailers.
- The allocation to alternative investments amounted to about 45% of the portfolio, which we deemed excessive based upon their objectives and risk tolerance.
- As a result, we reduced the alternatives allocation to a more reasonable level.
- We maintained exposure to one incumbent hedge fund that was closed to new investors and redeemed the rest, allowing them to invest in select hedge funds at more attractive fee structures.
Focus on Risk Adjusted Returns
- In this case, a client-family was under the impression that their investment portfolio had been properly constructed by their previous money manager to support current spending needs and maintain real portfolio value.
- Upon our review, we discovered an inconsistency with the stated objectives as the portfolio did not own sufficient growth-oriented assets to keep pace with inflation and grow the assets for future generations.
- Instead, we proposed and implemented an optimal long-term strategic asset allocation that positioned the family to achieve both objectives simultaneously.
Managing Mutual Fund Capital Gain Dividends Efficiently
- Each year, we evaluate capital gains distributions that are typically paid out at year-end by open-ended mutual funds, as these funds are required to pay out all gains recognized within the fund to shareholders.
- Colony is diligent in tracking all projected income and realized gains that are scheduled to be paid out to its clients that are mutual fund shareholders, and we cross reference the percentage of gains that is scheduled to be passed through, looking for opportunities to sell certain securities ahead of the record date.
- In this case, a client owned a mutual fund at a loss and there was a pending 7% capital gain distribution. We recognized the loss and entered a similar position to maintain the exposure and avoid the distribution.