Client portfolios constructed using
(i) Defensive Building Blocks,
(ii) Traditional Growth Building Blocks and
(iii) Alternative Growth Building Blocks.
The proportion of each will vary depending on client net worth, client goals, risk preferences, liquidity needs, and market conditions.
Understanding these three types of building blocks is a great place to start a discussion of how we build your portfolio and invest your capital to help you meet your financial goals.
I. DEFENSIVE BUILDING BLOCKS:
Cash, low credit risk bonds (e.g., short and long-term U.S. Treasury bond ETFs, gold, inflation protected Treasury bonds, long-vol ETFs, among others).
Defensive building blocks are investments that are expected to maintain value or appreciate in periods of above average risk (note that defensive building blocks are volatile like any other kind of investment asset, but they have defensive properties that help guard against specific risks that make them defensive). When constructing your portfolio, we give thought to a myriad of different risks that we are trying to defend against in your portfolio: falling markets, dollar weakness, increasing credit risk, and inflation just to name several significant risks we consider.
Defensive building blocks serve an important role in portfolios.
Another important asset class that serves as a key defensive building block is cash.
In periods of high market stress, or when otherwise useful asset classes are in a defined downtrend, W&C may substantially increase your allocation to cash to preserve your assets. Although cash is a low yielding asset today, it adds value by being able to serve as a safe store of value over short periods of time and because it provides a source of “dry gun powder” during volatile markets, while waiting for attractive buy opportunities to arise.
Another important component of Defensive Building Blocks are long-volatility assets. These are assets whose values will often go up in times of market turbulence (such as the ETF with ticker VXX).
II. TRADITIONAL GROWTH BUILDING BLOCKS:
Individual Stocks, U.S. Index ETFs, Sector ETFs, International Equity Indices, Real Assets, Commodities, Venture Capital, Private Equity, and Credit-Driven Securities et al).
Growth Building Blocks are securities and assets that are chosen for their potential to increase in value through capital appreciation driven by growth. Growth Building Blocks are risk assets that are commonly driven by GDP growth, industrial productivity growth, corporate innovation and profitability, individual and corporate income growth and retail spending to name some of the key return drivers. Growth Building Blocks can experience periods of high volatility and therefore we believe that they must be actively managed. We review positions in our strategies on a daily and weekly basis. Whenever possible we prefer to let winners run for longer periods of time.
An important sub-category of Growth Building Blocks that we regularly evaluate are hard assets, which include things like real estate and commodities like lumber, oil and grains for example. Hard assets tend to be quite cyclical. During inflationary times, these assets can provide useful sources of return. However, there are also times when hard assets experience down cycles and during those times, they are best avoided. Importantly, commodities do not always move in lockstep with the equity markets and can provide additional diversification to portfolios.
III. ALTERNATIVE GROWTH BUILDING BLOCKS:
Examples of alternatives include investment funds that purchase assets at enormous discounts from deeply distressed sellers, tax lien investing (over-collateralized loans), litigation finance, DIP lending, forex trading and CTA trading strategies (this list is just a sampling).True “Alternatives” can reduce portfolio risk by adding uncorrelated sources of return to the portfolio. The goal is to find investments whose returns are driven by factors that are materially different than those found in Traditional Growth and Defensive Building Blocks.
However, bona fide Alternatives are difficult to find. They are often illiquid with multi-year holding periods and tend to have high minimums and investor prerequisites.
In addition, historically, alternatives that are marketed on and accessed via Wall Street sponsored platforms, are imbedded with high and onerous fees.
Furthermore, many Wall Street firms have been capitalizing on the desire for alternatives by repackaging traditional growth assets and labelling them as “Alternatives” when in fact their return (and risk) drivers are no different than most traditional growth assets.
Due to their scarcity, our portfolios often have less allocated to Alternatives than we would prefer.
The fact that an investment is not publicly traded does not itself make it a bona fide “Alternative.”
We consider “Alternatives” to simply be a sub-set of “Growth Building Blocks” but distinguish them for the purpose of this write-up to provide you some additional insight into this widely marketed yet misunderstood investment ‘category.’