Market Cycle Mandates: Why They Work

Orion Portfolio Solutions provides a curated advisor experience when it comes to selecting investment strategies and constructing portfolios. It’s called Market Cycle Mandates

In short, Market Cycle Mandates (“MCM”) is simple to use and provides the structure for advisors to confidently build well-diversified portfolios. Confident advisors are more likely to create confidence in their client investors, which in turn creates better investor experiences. We consider this to be a win-win-win: for the investor, the advisor, and for Orion Portfolio Solutions (in that order).

The premise behind MCM is that great advisors help clients/investors navigate all market cycles with confidence. But that’s easier said than done. The markets are messy and volatile. Volatility creates emotional responses, which throw many investors off their plan.

Market movement is responsible for nearly 80% of portfolio return variance, according to a seminal industry study that was initially published in the Financial Analysts Journal, March/April 2010, Volume 66 called “The Equal Importance of Asset Allocation and Active Management” by Ibbotson and Associates. MCM provides a unique way to diversify client portfolios—beyond the traditional blend of asset classes—to prepare clients to handle the uncertainties of moving markets. The process is simple, and the story is compelling.

The diversification process revolves around three unique market participation questions, a supplement to the traditional risk assessment. These questions are designed to frame the diversification discussion, priming clients to understand the role of diversification in their portfolios.

  1. Global markets, though volatile, have historically been great engines for long-term wealth creation. Should a portion of your portfolio be exposed to the returns and volatility associated with these markets?
  2. Would you expect a portion of your portfolio to be actively managed during periods of market volatility?
  3. Should a portion of your portfolio be excluded from market movement during periods of market declines?

An affirmative “Yes” answer to these questions leads to these mandate allocations:

Beta mandate: Investment options that are designed to stay fully invested through market movement. When markets rise, these strategies may participate in the upside. However, when markets fall, these strategies may participate in a portion of the decline.

Active mandate: Investment options that are actively adjusted for changing market conditions. As markets become uncertain, these strategies may increase the defensive portion of your portfolio. Conversely, as markets rise, they may increase your ability to capture gains.

Diversifier mandate: Highly active investment options that may disengage from market movement and provide new sources of potential return and risk. These strategies tend to move differently than the overall stock and bond market.

The aforementioned study, “The Equal Importance of Asset Allocation and Active Management” by Ibbotson and Associates, is important academic support for MCM. This issue was summarized well in another CFA Institute article titled “Setting the Record Straight on Asset Allocation” by David Larrabee.

In short, the article refuted the fairly common view that asset allocation, often referred to as the BHB study, is basically the whole shooting match when it comes to explaining relative investment performance. The article, however, said that active management and tactical asset allocation were also still important drivers. This isn’t just important from a purely rational economic standpoint, but I also believe it’s important from a behavioral standpoint. Again, the markets are emotional and volatile. Most investors want/need investment strategies to adapt to changing market conditions.

To reinforce the notion that well-diversified portfolios should have exposure to strategies that behave differently in different market environments, here’s a quote from Larrabee’s article:

In “The Equal Importance of Asset Allocation and Active Management” from 2010, Ibbotson and colleagues James X. Xiong, CFA, Thomas M. Idzorek, CFA, and Peng Chen, CFA, studied 10 years of returns for more than 5,000 mutual funds in order to measure the relative importance of asset allocation policy versus active portfolio management. Through the use of cross-sectional regressions, they decomposed a portfolio’s return into its three components — the market return, the asset allocation policy return in excess of the market return, and the return from active management. Noting that BHB did not separate the market returns from the incremental impact of asset allocation policy, Ibbotson later summed up their findings as follows:

About three-quarters of a typical fund’s variation in time-series returns comes from general market movement, with the remaining portion split roughly evenly between the specific asset allocation and active management.

So what is the takeaway for investors? The original BHB paper sparked a wave of related research, most notably that of Ibbotson and his colleagues, that has advanced our understanding of asset allocation’s impact on investment performance. The studies collectively demonstrate the importance of (1) being in the market, and (2) doing a strategic asset allocation. And while asset allocation remains a critically important piece of the investment process, active managers can take heart that its importance was likely overstated by BHB.

To summarize, the Market Cycle Mandates program designed by Orion Portfolio Solutions seeks to provide well-diversified portfolios, supported by a clear and compelling investment process. MCM allows advisors to build, deliver and manage UMA portfolios with a unique diversification process that seeks to align investment decisions with client objectives, across various market scenarios.

To learn how Market Cycle Mandates seeks to deliver clients a common sense approach to managing portfolios regardless of external market variables, click here.

 

The CFA® is a globally respected, graduate-level investment credential established in 1962 and awarded by CFA Institute — the largest global association of investment professionals. To learn more about the CFA charter, visit www.cfainstitute.org.

The CMT Program demonstrates mastery of a core body of knowledge of investment risk in portfolio management. The Chartered Market Technician® (CMT) designation marks the highest education within the discipline and is the preeminent designation for practitioners of technical analysis worldwide. To learn more about the CMT, visit https://cmtassociation.org/

 

3022-OPS-11/11/2020

About Rusty Vanneman
Rusty Vanneman serves as the Chief Investment Strategist for Orion Advisor Solutions. An industry veteran with more than 30 years of investment experience, Rusty creates relevant market- and platform-related content that supports deeper, more engaging conversations with advisors and investors, educating key internal and external audiences on Orion Portfolio Solutions’ strategies and resources to help deliver favorable investor outcomes, and helps identify new investment offerings to meet growing marketplace demand. Rusty is a host of Orion’s The Weighing Machine podcast and authored the book “Higher Calling: A Guide to Helping Investors Achieve Their Goals.” Rusty has also managed multiple mutual funds and hedge funds during his career and was named one of the Top 10 Portfolio Managers to Watch by Money Management Executive in 2017. Prior to Orion’s acquisition of Brinker Capital in 2020, Rusty was the Chief Investment Officer for Orion Advisor Solutions and prior to that was the President and Chief Investment Officer of CLS Investments. Before joining Orion in 2012, Rusty served as the Chief Investment Officer and Managing Director for a multi-billion-dollar registered investment advisor (Kobren Insight Management) in the greater Boston area. His 11-year tenure at the RIA included a five-year span when the firm was owned by E*TRADE Financial where he also served as the Senior Market Strategist for E*TRADE Capital. Prior, Rusty was a Senior Analyst at Fidelity Management and Research (FMR Co) in Boston. Additional work experience includes Thomson Reuters, General Electric, and as a cattle ranch hand in the Nebraska Sand Hills. Rusty received his Bachelor of Science in Management from Babson College in Wellesley, Massachusetts, where he graduated with high distinction. He holds the Chartered Financial Analyst (CFA®) designation and is a member of the CFA Institute. He is also a Chartered Market Technician® (CMT) and is a member of the Market Technician’s Association (MTA).