Portfolio Construction

For our two absolute return strategies with no benchmark index (Global Macro Portfolio and Multi-Strategy Portfolio), we boil down the overall attractiveness of a fund into one number, which we call “utility.” Utility is calculated as follows:

Expected return
–  Systematic risk penalty
–  Residual risk penalty
–  NAV tracking error penalty
–  Expense ratio
–  Bid-ask spread
–  Commission cost
–  Borrow cost (for shorts)

=  Utility

After rank-ordering the attractiveness of all 400 ETFs and all 500 CEFs by utility (and eliminating close substitutes to avoid undue concentrations), we target weights for the 16 highest as follows:

  • 10.0% in #1
  • 9.5% in #2
  • 9.0% in #3
  • …..and so on down to…..2.5% in #16

at which point 100% of capital has been invested.  For our (long/short) Global Macro Portfolio, short target weights are similarly set for the funds with the most negative utility. This methodology has the effect of concentrating our holdings in the most attractive funds.  In practice, we typically establish positions up to within 3% of the target weight (maximum 10% as explained above), with actual portfolio weights usually 1%-3% below the target.  Targets may be updated daily, but we do not typically trade positions unless actual weights are outside of +/- 3% relative to the current target weight.  We find that this helps to reduce unnecessary turnover.

For our Custom Core Portfolios, we start by selecting an appropriate benchmark index for the portfolio, typically a target date or lifestyle fund.  Next we construct a custom strategic index of ETFs that closely mimic the risk and return characteristics of the benchmark index.  Then, we calculate the relative value of each of the ETFs in the strategic index.  Finally, using these tactical value indications, we establish target allocations to each ETF, which may vary between zero and double the strategic weight.