In the investment business, it is easy to talk about diversification: Most investors understand that it is beneficial to diversify their assets, so most investment providers focus their marketing efforts on their devotion to diversification. However, the measure of a firm’s commitment to effective diversification can be found in the strategy (or lack thereof) they employ.
At Capital Directions, our investment strategy is based on the science of investing built upon decades of academic research and institutional application. Our portfolios are designed to accomplish one, single task – to capture the market’s return while minimizing risk through prudent diversification. Our philosophy is firmly grounded in both Efficient-Market Hypothesis (EMH) and Modern Portfolio Theory (MPT).
EMH helps us understand asset pricing. It asserts that all known information is already reflected in the value of any asset, thereby making it is improbable to consistently uncover securities whose real value deviates from its market value. With millions of investors seeking the highest risk-adjusted return on their capital, competition quickly drives prices to their fair value.
MPT guides us in the construction of our portfolios. One of the most important and influential economic theories ever postulated (it won the Nobel Prize in 1990), MPT provides the framework for creating optimal portfolios by closely considering the relationship between risk and reward. MPT proved that by commingling poorly correlated asset classes together in a portfolio, the portfolio’s risk could actually be lower than the sum of its individual parts. MPT is the gold standard for prudent diversification; in fact, it was the underpinning of the Uniform Prudent Investors Act, which governs prudent fiduciary procedure in 44 states in the U.S.
Contrary to what Wall Street would like you to believe, market timing and security selection add very little, if any, return to a portfolio, and we eschew such tactics in our portfolio management. We do not follow the latest investment fads, chase performance or engage in will emotion-based trading in our clients’ portfolios. All of these activities will significantly reduce the probability of delivering the risk-adjusted returns that are there for the taking for investors – and their advisors – who stay the course.
Instead, using EMH and MPT as our guides, we focus our actions on factors that have a high probability of creating a successful investment strategy: 1.) Diversifying both within and across a wide variety of asset classes; 2.) Minimizing fees and transaction costs as much as possible; and, 3.) Maximizing our clients’ after-tax returns. Finally, we will closely monitor the portfolio to ensure the structural integrity is never compromised.
By embracing proven academic theories and building an investment strategy focused on factors that can be controlled, we can create portfolios that have a much greater likelihood of success for our clients than the typical trading-intensive, performance chasing approach that Wall Street sells investors.
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