Strategy Thesis

History has shown how otherwise rational Investors consistently overreact to both positive and negative information, causing booms and busts in financial markets. As a collective result, too many investors have experienced the shortcomings of an investment strategy that includes no mechanism to reduce the extent of a drawdown during market sell-offs.

We Believe the Investment Markets’ Inefficiencies Can Be Exploited

We have concluded that there are systematic market inefficiencies that can be consistently exploited by utilizing a ranking system that overlays price momentum and standard deviation factors on a specific lookback and holding periods. Based on our research, we believe a specific combination of the factors can improve total returns for a portfolio of equity investments and for a portfolio of fixed-income investments.

  • We believe the more important factor is price momentum. Research by Fund Architects and others shows that over time the strong tend to get stronger while the weak tend to get weaker – in other words, assets that have performed strongly in the recent past are more likely to outperform in the near term.
  • Including the volatility factor in the analysis can not only improve a portfolio’s standard deviation as compared to a passive benchmark, but it could also improve the annualized return compared to the portfolio that only adjusts for momentum. Maximum drawdown and the Sharpe Ratio are also significantly improved, according to our modeling.

1 MSCI All Cap World index NR. Growth of $100 initial investment with dividends reinvested. Source: Morningstar Direct. Time Period 12/31/2006-3/31/2017 2, 3 See Pg. 6 for additional disclosures on calculation of this hypothetical example. These are hypothetical examples for illustration purposes only. No fees have been deducted, as the results are not meant to represent client returns, nor are they meant to represent the returns of any Fund Architects portfolios. Growth of $100 initial investment, with no reinvestment of dividends or interest. Source: Fund Architects, LLC. Time Period 12/31/2006-3/31/2017

Multi-Factor Ranking System

The Fund Architect investment offerings are driven by the Firm’s proprietary Multi-Factor Ranking System℠. Utilizing a combination of specific price momentum and risk factors, the research-based model attempts to improve total returns and risk-adjusted returns for portfolios of equity or fixed-income securities.

The System includes a series of incremental components that, when taken together, represent a whole we believe to be greater than the sum of the parts.

  1.  A defined investment universe

    We believe that the most important characteristic for positions in the Portfolios is to have varying correlations. Relying on that tenet, our equity rankings include broad equity regions, global sectors, cash options, and U.S. Treasuries, while our fixed income work includes convertibles, preferreds, high yields, and bank loans. In the end, diversification benefits don’t come from the number of positions held within a portfolio, but from the correlation relationship between the positions.

  2. A defined lookback

    Our research says optimal lookback period is between three and four months or around 75 trading days. Any longer, and the system does not react quickly enough to changing market conditions; any shorter and the system becomes inconsistent as it trades around market ‘noise’. In any event, the lookback period should always be longer than your holding period.

  3. A defined holding period

    Our analysis indicates that the optimal holding period for sector investments is one month. This period gives the momentum factor time to materialize while reducing transaction costs and portfolio turnover.

  4. A sector ranking scoring system

    Our research shows that ranking should primarily be driven by price momentum with standard
    deviation a subordinate factor. Inside the ranking algorithm, price momentum produces about two-thirds of the score.

Glass Box Portfolio Construction

The Fund Architects Portfolios are built using a fully transparent management process that combines the results of the Multi-Factor Ranking System with the Investment Committee’s assessment of current market opportunities.

70% of portfolio assets are invested based on the quantitative results of the Multi-Factor Ranking System to overweight areas of the market the system favors. 30% of portfolio assets are invested based on a qualitative review of the market to provide.

Portfolio Implementation

At the first of each month, the top two ranked segments as identified by the Multi-Factor Ranking System are purchased or traded for the Portfolios. Other positions in the Portfolio are chosen and managed by the Investment Committee on a continual basis. Very importantly, the Portfolios can invest completely in cash or U.S Treasuries when appropriate.

The Portfolios rely on low-cost, high-quality ETFs to not only ensure the Portfolios are gaining the desired asset exposure at the lowest total cost of ownership but to eliminate manager tracking error. ETFs are an essential – and not to be overlooked — element in maximizing the risk-adjusted, after-tax, net-of- costs return for the Fund Architects Portfolios.

The chart above is calculated internally using Morningstar Direct software, and utilizes historical data for trades placed in the model portfolio. Performance data may not be representative of any individual client account as actual client account results may be lower or higher due to account specific activity. The performance data shown represents past performance, which is not a guarantee of future results Investment returns and principal value will fluctuate, so that investors’ shares, when sold, may be worth more or less than their original cost. This data has not been audited by an independent third-party source and has not been prepared to meet compliance with the Global Investment Performance Standards (GIPS®) No representation is made that the above performance is indicative of the experience of any one client. The performance shown is net of a 1.5% annual management fee and net of internal fund expenses. Dividends and interest are reinvested.