Passive Investing

Passive Strategy in Your Portfolio

Recently, I had the pleasure of meeting with Patrick A. Sweeny, co-founder and principal of Symmetry Partners, LLC based in Glastonbury, CT. An investent advisory firm registered with the Securities and Exchange Commission, Symmetry offers strategically allocated, broadly diversified portfolios for the clients of independent financial advisors across the country.

I first met Pat at a conference at the University of Chicago in 2007. We were both speaking at the engagement, and fortunately, I had the opportunity to hear Pat’s presentation on passice investing — a principled, academic approach that believes in the efficiency of the markets, and in leveraging priced risk factors in an effort to capture greater returns over time.

During our recent meeting, Pat and I reviewed the Symmetry strategy and how it came to be.

A veteran of the financial services industry, Pat began his career on the institutional side of the business trading commodities, stocks and bonds. After working this side of the business for a number of years, he eventually changed directions and began growing a business by helping retail clients develop strategies designed to help them reach their long-term goals. It was then that he began to study how academics looked at investing vs. how Wall Street was practicing it with the retail investor. Unfortunately, Pat saw some conflict of interests between the academics’ main goals of finding truth and educating as opposed to Wall Street’s objective of turning a profit.

It was during this time that Pat met his partner, David E. Connelly, Jr., and together, they believed that they could do a better job for their clients by applying academic research to the practical world of investing through a structured investment strategy. Similar to index investing, structured investing offers a principled, buy and hold approach that has its foundation in academic research. Among the key tenets of their strategy is a belief in the efficiency of the markets, the importance of broad diversification, and exposure to prudent risk factors.

The Efficiency of the Markets

The notion of market efficiency was introduced by Professor Eugene Fama of the University of Chicago in the 1960s. Quite simply, the Efficient Market Hypothesis states that the markets incorporate information very quickly and very effectively, so the best estimate of a security’s value at any point in time is its current price. As such, any attempt to profit from mispriced securities would be difficult at best. Unfortunately, many investors have a tendency to buy what’s hot, as opposed to buying a strategy, in the hope of beating the markets. For example, if someone is holding an investment that isn’t performing well, the investor will often look for something else to replace it. Unfortunately, when you sell your losers and buy something else that is doing well, you end up selling low and buying high — exactly the opposite of what you should be doing — essentially ensuring that you’re going to trail the market.

Dalbar, Inc., a leading financial research firm, has been able to quantify how investor behavior has affected portfolio returns. Over the past 20 years, the S&P 500 Index of U.S. large cap stocks hs returned about 8 percent annualized over the period. Unfortunately, the average equity fund investor has earned just over 4 percent annualized. Why? Rather than following a buy and hold strategy, the average equity fund investor likely moved in and out of different investments in an effort to beat the markets as evidenced by the fact that the average holding period for his investments was just over three years. *

The Benefits of Broad Diversification

While many investors may understand the concept of diversification, some have difficulty implementing it effectively. For example, some ivestors may own four, five, 10 or maybe even 20 different mutual funds thinking that they’re diversified. What they may fail to realize, however, is that when you look under “the hood,: they may have tremendous overlao in their portfolios with respect to specific asset classes or securities that can substantially increase their level of risk. Through broad diversification, investors are able to benefit from those areas of the markets that are performing well, without being overly exposed to those that are lagging.

Symmetry practices broad diversification using institutional class mutual funds from Dimensional Fund Advisors in their structured portfolios. Through the structured portfolios, investors gain exposure to more than 12,000 securities from nearly 50 countries around the globe. Similiarly, their low-cost, exchange traded fund solution features global diversification with exposure to more than 15 different asset classes represented by more than 5,000 securities.

Exposure to Compensated Risk Factors

In addition to building diversified portfolios, Symmetry seeks to enhance returns through the exposure to several compensated risks — also know as factors — that have historically contributed to greater returns over time.

For example, stocks are typically riskier than bonds, so investors have been compensated over time for the additional risk of investing in stocks over bonds.

Similarly, since small company stocks are typically more volatile than their large cap counterparts, investors in small company stocks have been historically rewarded with a premium above the returns of large company stocks. With respect to value vs. growth stocks, value stocks have historically offered greater returns over time given the additional risk of investing in these low-priced, distressed companies as opposed to investing in stronger, high-quality growth companies.

If risk and return are related, and we believe they are, then investors must be compensated for taking on greater risk. Investing in a way that seeks to benefit from these factors is what really differentiates the Symmetry strategy from traditional indexing. While Symmetry’s balanced portfolios buy and hold thousands of stocks from all over the world, they also overweight small companies, here and abroad, as well as low priced, distressed companies in an effort to capture the higher returns that these factors have traditionally provided.

A Core Holding for Your Portfolio

While some investors may enjoy picking and choosing different stocks, bonds, mutual funds or money managers, we believe a principled, broadly diversified strategy that seeks to optimize returns while mitigating volatility should be at the core of most investors’ portfolios. When investors are able to choose a suitable mix of stocks and bonds based upon their unique risk tolerance and time horizon, we believe they are better positioned to stay true to their investment strategy while enjoying a more satisfying investment experience overall.

* DALBAR 2013 QAIB – Quantitative Analysis of Investor Behavior, covering the period of January 1, 1993, through December 31, 2012. Past performance is no guarantee of future results.

Standard and Poor’s 500 Index rpresents the 500 leading U.S. companies, approximately 80% of the total U.S. market capitalization.

Indices are unmanaged. Investors cannot directly invest in an index. Indexes have no fees. Historical performance results for indexes generally do not reflect the deduction of transaction and/or custodial charges or investment management fees, the incurrence of which have the effect of decreasing historical performance results. Actual performance for client accounts may differ materially from index portfolios.

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