Investment methodology

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Investment Methodology

ISA portfolios are designed to help investors navigate significant and unstable movements in financial markets to obtain potentially increased returns. Portfolio results are achieved through disciplined risk management, situational awareness, global diversification and dynamic asset allocation.

ISA is leading investors toward new avenues of risk management and portfolio growth.




1. Capital Preservation

Diversification through asset allocation works, but It needs to be more dynamic.

As witnessed during the Credit Crisis of 2008-2009, the benefits of diversification may not always perform to expectations. One way to maintain an equity allocation favorable for growth while introducing a level of downside risk management is dynamic asset allocation.

ISA Portfolios apply dynamic asset allocation strategies through overlay risk management to minimize fees, maximize the capture of a rising market, and facilitate an efficient flight to safety when markets turn for the worse.





Diversification through asset allocation works, but It needs to be more dynamic.





For periods of one to five years since 1926, most portfolio blends delivered positive real or after-inflation returns.For periods of one-to-five years since 1926*, most portfolio blends delivered positive real or after-inflation returns. In longer holding periods, larger equity exposures generally raised the frequency of positive real returns.

*Average portfolio performance between December 30, 1926 through December 30, 2010. Source: Standard & Poors





Volatility limits performance.

Because volatility is time varying, “annualizing” performance cannot provide a complete or transparent measure of a risk management approach. Through dynamic asset allocation, and overlay risk management, risk adjusted performance can be more readily achieved and measured. This experience emphasizes the need to incorporate shorter-term emphasis into risk management practices that typically are built with historic long-term returns in mind.

ANNUAL MARKET RETURNS 1927-2008





On a long term basis and throughout all of history, stock returns are more highly correlated during volatile market downturns than during market upturns, exacerbating the risk consideration for equity investors.

U.S. EQUITY MARKET TOTAL RETURNS, BY STYLE*

*From market peak to bottom(October 2007 through end March 2009)





Normally, investors can count on bonds or alternative investments to help cushion the impact of volatile equity market downturns.However, this was not true in 2008 for corporate bonds, which sold off alongside equities. While the Lehman (now Barclays) Aggregate Index generated a positive return, this mainly reflected a rally in treasuries. Nonetheless, because fixed income managers typically do not have large treasury holdings, returns for the vast majority of bond managers were considerably below their benchmark. Finally, alternative investments failed to offer any downside protection. Thus, 2008 returns were negative for every category. Consequently, with the exception of cash and treasuries, portfolio construction made little difference to investment returns.





Making matters worse, unprecedented correlation levels have been steadily rising in the U.S. since 1995 and world-wide since 2003.





In equities, the case for dynamic asset allocation vs. traditional diversification is perhaps best punctuated by the new reality that growth stocks are priced the same as value stocks.




2. ISA's Multifactor Risk Management

Simple Classification

Risk is assessed from the interactions between three groupings of factors: Behavioral, Catalyst, and Technical.

Rigorous Analysis

The causes of declining markets are multi-faceted; they are not influenced by a singular factor. ISA algorithms analyze dimensions of 33 sub factors, their interactions and the extent of their determination on market returns.

Timely Execution

Risk factor data are used to determine the optimal portfolio composition for the prevailing market environment, while also monitoring the current portfolio’s susceptibility to market risk.

By managing the exposure of the portfolio to well understood risk factors, capital can be protected from downward trending markets before it is too late.




2. ISA's Multifactor Risk Management

For greater clarity within immensely complex inter-market dynamics, we manage risk factors within three categories:

Technical Risk Factors depict in quantifiable detail, the trends forming between traders across global stock exchanges.

Behavioral Risk Factors of market participants express whether investors are bullish (paying more for stocks) or bearish (paying less for stocks), which establishes the direction of a trend and helps to formulate estimations of the duration of that trend.

Catalyst Risk Factors are tracked as event overlays to technical and behavioral factor price data and can be evidenced either by news and/or price trend anomaly, whichever emerges first.




2. Multifactor Risk Management

When markets turn negative, the shift in sentiment is reflected not only in the prices of stocks, but it is often preceded by shifts in the attitudes of market participants, transaction data, and world events.





Behavioral risk factors extract the details of live transactions, revealing how changes in investor sentiment impact stock prices.Behavioral risk factors reflect the subjective buying and selling decisions of market participants. These datainclude the rolling advance/decline ratio and its rate of change. For example, if a stock market index is rallying,but there are more issues declining than advancing, then the rally is narrow and much of the stock market is notparticipating. This data set also incorporates bid & ask volume ratios, bid direction and size, the moving averageof the put/call open interest level, momentum, and institution accumulation/distribution. These data provideISA algorithm engineers with objective, emotionless insight into changing market dynamics.





Technical risk factors monitor the key price and time relationships of money flow between global institutional money managers and the investing public.Investors respond to each others' actions while being influenced by specific expectations and predictions ofmarket prices. The historical transactions help to form perceptions of overbought or oversold levels. When livetransactions approach previous levels, common technical indicators such as moving averages, mean reversion, and support or resistance become prominent influencers.





Catalyst risk factors fuel the momentum of buying or selling, leading to a majority sentiment, response, and subsequent trend.Timeline example of a catalyst risk factor impact: April 16, 2010. SEC charges Goldman Sachs with fraud instructuring and marketing of CDOs tied to subprime mortgages.





Catalyst risk factors can be impactful beyond their original time and space.Stock market returns April 15-May 10, 2010 following catalyst risk factor on April 16, 2010 when the SEC charged Goldman Sachs with fraud in structuring and marketing of CDOs tied to subprime mortgages.





Understanding risk factor interactions is as important to decoding the conditions that lead to market turbulence as understanding the factors themselves.




3. Situational Logic

Situational logic guides the algorithmic calculations of how changes between risk factor interactions are transmitted to and from financial markets. Situational logic improves upon a "black box" only approach by seeking contextual answers to the questions most relevant to effectively managing an investment portfolio based on what is happening in the market right now versus what happened in the past.

Situational logic helps by selecting the most relevant factors and allows for a more thorough understanding of the portfolio's exposure to different variables, which impact risk factors at different times and in differentways, allowing for analyses that are more precise and lead to better-informed investment decisions.

Risk must be understood in the context of probability. This understanding can only be achieved with a firm grasp of the factors relevant to the present reality.





Causal risk factors and symptomatic risk cycle time variation is important to asset returns. Even within short time frames, catalyst risk factors with clear historical relationships shift in scope and complexity as the situation worsens, preventative measures are taken, and the risk of contagion spreads. The graphic illustrates the sovereign debt contagion’s impact and increasing pace of varying Euro zone credit crisis risk factors through the summer of 2010.

Our risk model is not purely dependent on historical relationships, but incorporates 'real time' facts that influence causal interactions.





Selecting the maximum risk factor levels a portfolio is exposed to requires a thorough understanding of each variables time varying relevance.





Risk factors are tightly linked when systemic risk is high and indicate a fragile market with increased potential for a collapse of prices.





Accurate assessment of portfolio risk requires asking the right contextual questions about the present situation.





Question 2: What are the longstanding impactful changes within factor interactions?





Question 2: What are the longstanding impactful changes within factor interactions?




4. Enhanced Return

...and a quarterly rebalance can provide preemptive protection from most corrections.

In the S&P 500, from January 1926 to December 2010, declines of 5% or more occurred an average of 3.7 times per year. Declines of 10% or more occurred 1.3 times per year, while declines of 20% or more occurred only 0.5 times per year.




4. Enhanced Return

For the past 25 years, one or more pre-identifiable ISA risk factors have preceded market corrections over 86% of the time.




Investment advice and portfolio management for the new era

Index Strategy Advisors develops objective, thoughtful solutions to the strategic and tactical investment challenges faced by individual investors. Our research is the foundation for our thought leadership and advisory services for investment management clients in the areas of dynamic asset allocationand risk management.

Our expertise is supported by algorithms built in-house for conducting strategy back-testing, scenario planning, risk reduction, optimal asset allocation analysis, and precise trade execution in line with client-specific investment guidelines, risk tolerance, and return requirements. In response to therapidly expanding supply of highly focused exchange traded funds (ETFs), our library of algorithms has been expanded to include ETF screening analytics for assessing and proactively identifying the optimal ETF securities for portfolio construction.

Our goal with research is to challenge ourselves to think beyond yesterday's assumptions and to seek insights and innovative thinking that breaks new ground and newly define - or redefine - areas of opportunity for investors.




See how we put our methodology into action

A retired entrepreneur in his mid 60s requested that ISA develop a hedging strategy that could reduce the impact of equity market volatility on his $10M fixed income holdings, which represented approximately 65% of the overall portfolio. Included in this example is the analysis we performed and the recommendations that were made.

http://www.indexstrategyadvisors.com/second-opinion






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Investment methodology