Passive Management: The Six Step Process

The following six steps provide investors with an outline for organizing and monitoring a portfolio.  Specific details of implementing these guidelines can be found by tracking one of the ITA Portfolios.

1.  Determine the portfolio objectives.  Consider the following as possible reasons for constructing the portfolio.

  • Is this a retirement portfolio?
  • Is it a higher education portfolio?
  • Is it a trust or endowment portfolio?

2.  Analyze what asset classes to include.  Begin with the three major classifications of equities, bonds, and cash.

3.  Develop a Strategic Asset Allocation plan that meets the portfolio objectives.

  • Is a complex portfolio manageable?
  • Divide the broad equities asset class into smaller sub-classes to include value, growth, and various cap sizes.
  • Consider developed international markets as well as emerging markets.
  • Diversify into REITs and bond asset classes.

4.  Select investments to fill the asset allocation plan.

  • Once the asset classes are identified, find index investments to fit the asset classes. Example: Use Vanguard's Total Market ETF, VTI, to represent the U.S. market.
  • Build a portfolio core around index funds or index ETFs.  Our preference is to use Exchange Traded Funds.
  • If the manager is highly skilled in stock analysis, a small percentage may be allocated to individual companies.

5.  Determine what percentage to allocate to each asset class.

  • What percentage to allocate to each asset class is the most difficult of all investment decisions.  Use the Dashboard worksheet within the TLH spreadsheet as an aid.
  • Asset allocation percentages come down to personal choice, but the decisions should fulfill the portfolio objectives.
  • Endowment funds will have different allocations than college portfolios.

6.  Implement, manage, and monitor the plan.

  • Portfolio tracking is essential.
  • Develop a plan for rebalancing the portfolio.
  • Understand the concept of Internal Rate of Return (IRR).
  • Develop a benchmark for the portfolio.
  • Understand and measure portfolio risk or uncertainty.

The above six steps form a broad outline of how to approach portfolio construction, management, and monitoring.  The specifics of how to follow these steps is modeled on a regular basis as readers track the development of the various portfolios.

Bohr Portfolio Examined

This month the Bohr Portfolio received an infusion of cash and reduced shares of TLT to pull down the percentage held in the over allocated bond/income asset class.  A few May dividends were added keeping the IRR for the portfolio well ahead of the VTSMX benchmark and in line with the ITA Index, a customized benchmark.

Shown below is the current Dashboard for the Bohr.  Limit orders are in place to bring the various asset classes back into balance, but the orders are set well below the current prices so it will be weeks before we see much action.

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