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Our Clients Are Asking... July 2023 Thumbnail

Our Clients Are Asking... July 2023

As our firm's Chief Investment Officer (CIO), I am frequently asked about current market conditions, the direction of the economy, and our portfolio strategies. I'm pleased to provide our responses to some of the most FAQs. Today's focus is on how we put together client portfolios.

Who chooses the funds in my RRCM portfolio?

It's a two-part process.

Your RRCM advisor works with you to set your personalized mix of cash, bonds, and stocks. Your mix is based on your tolerance for risk, your time horizon, your need for liquidity, and other factors unique to your situation. 

Our firm's Investment Committee is responsible for creating model stock and bond portfolios, each consisting of specific mutual funds and ETFs. Stock and bond funds chosen for your personalized portfolio mix are based on these models. 

This ensures consistency across all client portfolios—all clients receive our best and most current thinking. Client portfolios that have similar asset mixes will utilize the same fund strategies and have similar performance.

Of course we also will personalize holdings based on tax considerations, legacy securities, etc.

Why Vanguard and Dimensional?

Our Value Added Indexing® approach utilizes managers that track market performance closely. As such, we limit our universe of potential managers to those that either are “pure” indexers, or managers that look to provide the market’s returns with additional emphasis on factors that have added value over time. We do not use traditional active managers that attempt to outperform the markets though timing or security selection. Over time, most active managers fail to beat their benchmarks.

In other words, we look to own the haystack, not the needle!

Looking for stocks expected to outperform can cause active fund managers to take on more or less risk than expected, perform worse than the overall stock market, or drift from their stated style. Their returns can then deviate significantly from those predicted by a financial plan.

Market tracking funds are predictable and consistent in delivering the returns of their underlying asset classes – a critical element in meeting the goals set out in a financial plan.

Based on these criteria, we have chosen to use as our primary managers Vanguard (for bonds) and Dimensional (for stocks), given the excellence and long track records of both firms in following this approach to investing.

Vanguard - Their fixed-income funds that we utilize primarily look to match the return of a particular area of the bond markets at an extremely low cost.

Dimensional - Their portfolio management is based on the premise that markets are efficient in setting prices. Similar to Vanguard index funds, Dimensional portfolios track the markets closely, but offer modestly higher weights to securities within “dimensions” of the markets that historically offered higher expected returns, such as small cap stocks, cheaper “value” stocks, and companies demonstrating consistently high profitability.

Do you make tactical adjustments based on changing market conditions?

We are long-term, disciplined investors and do not make short-term tactical adjustments or try to time the markets based on predictions or changing market conditions. Research shows that these efforts are difficult to implement and do not add value over time. Rather, changing markets often prompt us to rebalance portfolios back to their target range. 

Rebalancing is an integral part of our portfolio management process. Each portfolio component (i.e. U.S. stocks) and asset class (stocks as a whole) is assigned a target weight. Generally, if the component or asset class has moved 5% beyond its target, it is subject to rebalancing. Generally, portfolios are rebalanced 50% of the way back towards the target weights. We use cash additions or distributions from a portfolio to rebalance as well.

Our Investment Committee will on occasion implement longer-term strategic changes to our portfolios. For example, given the inverted yield curve (short-term interest rates higher than long-term rates) and the generous yields available on cash, we recently moved a portion (approx. 20%) of our bond allocation into money market funds.

Do you consider environmental, social, and governance (ESG) factors in constructing portfolios?

We feel that clients should drive the approach to implementing ESG factors in portfolio management. Our core portfolios track the markets closely, without ESG overlays or consideration. For clients that wish to implement an ESG approach, we offer stock portfolios managed by Dimensional that incorporate an emphasis on sustainability.

Their approach, in typical Dimensional fashion, is based on science and research. Through a quantitative process, they score companies and industries in both environmental and social sustainability.. 

Greenhouse gas emissions intensity is the largest component in their sustainability scoring system, though other variables such as land use, biodiversity, and water management are also considered. Social sustainability looks at issues deemed to have a negative impact on our society, such as civilian firearms manufacturing.

Based on scores from both categories, Dimensional then excludes or underweights stocks or industries with poor sustainability profiles, while emphasizing companies and sectors with better profiles. All while maintaining their traditional focus on broad diversification and pursuing higher expected returns through increased weighting to small cap stocks, cheaper value stocks, and companies with higher profitability. The track records of Dimensional's Sustainability Funds show that investment performance does not have to be sacrificed to take a green approach.

David Rappaport, CFP®

David is the Co-Founder of Rappaport Reiches Capital Management.  He acts as personal CFO to entrepreneurs and corporate executives, providing organization and clarity in their finances. Please connect with David below.  He loves to talk about investing, financial planning, and Aspiritech, a non-profit hiring individuals on the autism spectrum.

The author does not intend to provide investment, legal or tax advice as these materials are for general educational purposes only. Please consult your legal, tax or investment professional for advice on your particular situation. This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. It is not intended to be a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction. Investing involves risk including the possible loss of principal. Past performance does not guarantee future results. Please refer to RRCM’s Form ADV Part 2 for additional disclosures regarding RRCM and its practices.