Investment Models
Investment models provide a systematic way to diversify a portfolio among non-correlated asset classes, thereby optimizing the interaction between risk and reward. Most people's financial needs are quite similar, and having standardized models helps I-Pension keep your costs down.
Our models have been developed and tested by a third-party Chartered Financial Analyst (CFA) with over 25 years of investment experience. The CFA designation is "an international professional designation... for finance and investment professionals, particularly in the fields of investment management, investment banking and financial analysis of stocks, bonds, and their derivative assets." The bottom line is CFAs are smart people, and we rely on ours to build and monitor each of our investment models.
All of the I-Pension investment models use diversification and correlation as the key determinants for selecting investments. The vast majority of I-Pension clients fall into one of five standard models:
- Conservative
- Moderately Conservative
- Moderate
- Moderately Aggressive
- Aggressive
Diversification and Correlation
All investments go up and down. The level of correlation between two different asset classes is determined by how they go up or down in relation to the other. For example:
- If Asset Class A tends to go up or down at the same time as Asset Class X, they are said to be highly-correlated.
- If Asset Class B tends to go up when Asset Class X goes down, and vice versa, they are said to be inversely-correlated.
- If Asset Classes C and X seem to move up and down in unrelated ways, they are said to be non-correlated.
As an investor, the benefit of having non-correlated or inversely correlated asset classes is that you are more likely to have some investments going up as others are going down. This will dramatically even out the volatility of your investing experience. You may not earn as much when the market is booming, but you also won't lose as much when the market is tanking.
How We Create Our Models
Here's the process I-Pension follows:
- Develop asset class inputs: The first step is to analyze the broad asset classes and construct long-term expected returns (performance), standard deviations (risk), and correlation percentages (how each asset class performs in relation to the others). This analysis is based on a combination of historical data, current market information, and qualitative analysis.
- Create asset class models: The asset class models are built based on "mean-variance optimization," a Nobel prize-winning economic theory. In simplest terms, this optimization process looks at the expected risk and return of each asset class and determines which combination of asset classes will provide the highest expected return for a given level of risk.
- Construct portfolio: Once the asset class models are determined and the investment options are analyzed, we determine the appropriate combination of the investment options.
- Monitor the portfolio: We continually monitor and review each portfolio to ensure that it stays in line with its stated strategic asset allocation target. There are many reasons why a strategic asset allocation or fund-specific portfolio may need to be changed over time. Varying market conditions, manager changes, and fund style drift are just a few of the factors that can cause a portfolio to shift from its stated objectives.
- Rebalance: Once your account is established and allocated, I-Pension continually monitors the global markets and your account and rebalances or reallocates as necessary. I-Pension uses a rules-based system, an approach we believe is preferable to the more common calendar-year rebalancing whereby portfolios are automatically rebalanced at a pre-determined time, usually annually but sometimes quarterly. Rules-based rebalancing works quite differently.