Our Value Proposition
Our organization was formed on the premise that large investors, multi-billion dollar pension plans, endowments and foundations tend to do a better job of navigating capital markets than smaller institutions or individual investors.
Why is this?
In our opinion there are two primary reasons for this discrepancy.
At iCM, we use our collective purchasing power, independence and professionalism to deliver those same advantages to those who choose not to amortize the cost of a fully staffed investment department.
S&P 500: 11.1%
Stock Fund Investor: 3.7%
Small endowments underperformed
by 1.5% – 2%
S&P/Individual Investor Returns – Dalbar QAIB Study 2014, Data 30 Years Ending 12/2013
Endowment Results – 2014 Nacubo-Commonfund Endowment Study
Our Investment Thesis
Investing at iCM begins with an uncommon, but powerful investment thesis. Many investors, both individual and institutional, experience subpar results with their investment programs because they focus on the wrong thing. In our experience, investors tend to focus on return and ignore risk until it is too late. This leads to two damaging consequences:
The Fallacies of Investing
In conjunction with our prior discussion on Investor behavioral tendencies that lead to error, there are an additional set of preconceived notions that lead to equally damaging results. We refer to these as the iCM Fallacies of Investing and they represent common investor practices that at the surface seem quite reasonable, but tend to be flawed for a variety of reasons. To better frame this lesson we pose three questions:
1. There have been two bad financial bubbles in the last 15 years. Do you believe it can happen again?
Most will answer yes to this question. The reality is that bubbles have existed throughout history in our own stock market including bubbles in 1901, 1929, 1966, 1999, & 2008. Non-US markets have also experience financial bubbles, including the Japanese equity and real estate bubbles. Many will present the Dutch Tulip Bubble in 1637 as the first speculative bubble.
2. Do you believe that most things in the world are perfect at all times?
While there are some things that happen most of the time, there are few things that are perfect at all times.
3. Do you believe financial markets are perfect?
If financial markets are perfectly priced at all times, there should be no deviation from fair value and, as a result, bubbles would not exist. Most would agree that financial markets like many things are not perfect at all times.
In order to be successful as an investor it is vital to have a well-articulated investment philosophy that is based on tried and true investment principles.
While a focus on investment philosophy permeates the large-dollar investor landscape, in our experience, it is surprising how little focus is given to investment philosophy by smaller institutions, individual investors, and even some financial advisors. Philosophy is crucial to your success as an investor; it is essentially the road map, blueprint, or even genetic code of an investment program. That is, investment philosophy defines our very character and nature.
We designed our site with this in mind.
A child with both parents exceeding 6 feet in height is less likely to be below average in height than those that are born from two parents that are both 5 feet tall (Reuters 2014). Philosophy epitomizes a permanent state of individuality.
"It is said an Eastern monarch once charged his wise men to invent him a sentence, to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: 'And this, too, shall pass away.' How much it expresses! How chastening in the hour of pride!—how consoling in the depths of affliction! 'And this, too, shall pass away.' And yet let us hope it is not quite true."
Our investment philosophy begins with a clear objective and the following observations in mind: To construct well-diversified portfolios that will generate positive excess returns, relative to their policy benchmark, over the course of a full market cycle. A market cycle can be defined as a period of general business activity measured from the peak of the prior business cycle to the peak of the current business cycle. Market cycles generally cover a 5-7 year period, but can be longer or shorter.
- Diversification is a critical step in portfolio construction.
- Performance variability is dominated by asset allocation decisions.
- Active & passive risk decisions affect terminal wealth.
- Valuations matter.
- Markets are long term efficient, can be short term inefficient.
- Mean reversion can add or subtract value.
- Market timing is destructive.
- Successful investing requires conviction & discipline.
With the above observations in mind, our philosophy features several core beliefs.
- At iCM risk is managed through a budgeting process.
- Regardless of the changing nature of returns, volatility will always be present.
- We believe that over long periods of time, most markets are fairly efficient.
- We believe that just about anything important in making an investment decision exhibits a mean reverting quality.
- We believe that while valuations matter, relative valuations matter more and are more easily interpreted.
We believe that over the course of a full market cycle, an actively managed asset allocation can act as a mechanism to reduce risk and enhance returns. We understand that periods of over and under valuation can persist for extended periods of time, and believe that patient investors are rewarded.
Two critical elements in our investment process are conviction and patience in the face of adversity.
As such, having a control mechanism in place acts to reinforce conviction in the face of adversity and as a check and balance mechanism. By acquiring out of favor assets, we recognize that markets can ignore valuations in the short term causing our performance to trail until markets revert to their long-term equilibrium relationship.
We view this temptation to capitulate as the price that we pay for excess returns. In such cases, valuations will act as our control mechanism. We will continue to be steadfast in our convictions until valuations point us elsewhere.
At iCM we take investment philosophy very seriously. While there are many intricacies to our own investment philosophy that we invite you to explore, central to our belief system is the concept that Valuations Matter. For investors with long term goals exceeding a market cycle, but shorter than the 100 years that most would consider to be an academic time horizon, few things matter more in driving risk and return in asset classes than valuations, in particular beginning period valuations.
iCM's investment process is a manifestation of our investment philosophy. That is, Our belief system should be apparent in the implementation of our portfolio.
- Tactical Decision: Over or underweight decision as well as product selection implemented in a series of meaningful steps building into a position as valuations become more compelling.
- Long Term Capital Markets Expectation: Historical estimates of risk and return.
- Long Term Valuation Analysis: Quantify the return opportunity from various valuation levels.
- Current Valuation Analysis: Measure and quantify fair value as well as dispersion from fair value while being mindful of paradigm shifts.
Benchmarking & Performance Attribution
Periodic performance measurement & evaluation is a critical step to any investment process if taken in the proper context. The purpose of benchmarking & performance attribution in the short term is not to determine success or failure of a manager team. The purpose of periodic short-term evaluations is to better understand the determinants of performance, so as to better understand risk as it relates to a manager or portfolio. In order to get an accurate reading on manager skill, a manager/program must be given the benefit of a full market cycle, as measured from the prior peak level of general business activity to the next peak of general business/economic activity (usually 5-7 years), for performance alone to be meaningful. All clients are given access to a real time performance monitoring system where the portfolio returns, asset class returns, holdings returns, and benchmark returns are updated daily, allowing for real time monitoring of your investment dollars.
Understanding the Importance of Risk Management
in the Active Space
To truly understand and manage risk in investment portfolios, one must first acknowledge that this is not a single dimensional challenge, but a multi-dimensional one. In our experience, most investors, and for that matter most investment providers, acknowledge risk in terms of overall volatility within a portfolio. While this is important, it stops short of having a true grasp on total portfolio risk. For us, risk begins with total portfolio volatility, but extends into active risk & active share. Most importantly, we seek a full understanding of the sources of these risks.
This can be thought of as the movements of a portfolio around its expected return. In a statistical sense this can be explained by variance and standard deviation.
While some tend to confuse trading frequency or activity with active risk, the two are only very loosely related. Simply stated, active risk is the degree to which your portfolio behaves differently than its stated benchmark. In order for a portfolio to be truly active, one must invest differently than the benchmark to achieve this goal. There is no way to invest in the identical securities in the exact weights and do anything other than match the benchmark’s return. As such, in order to outperform, one must be willing to vary from their stated benchmark and be willing to underperform in the short-term to achieve long-term success. This can be accomplished through frequent trading, but it is not the only option. In fact, one can own a low turnover portfolio comprised of a small portion of the S&P 500 and show a rather large degree of active risk or variation from the S&P 500. In a statistical sense, active risk is tracking error or the standard deviation of excess returns.
Active share relates to the degree that a manager takes active decisions versus their stated benchmark. While a high active share does not imply that a manager will outperform their benchmark, academic research has shown that managers that exhibit a high active share have outperformed those that take less active decisions (See ‘How Active is Your Fund Manager?’ Cremers, Petajisto, 2006). At iCM, we examine active share in conjunction with active risk to better understand a manager’s investment style, the source of their excess returns, and build future return expectations.
Active Risk Contribution
Active risk contribution speaks to the active risk a single stock, bond, or for that matter, manager may control within your portfolio. While this may seem simple at heart, it escapes many investors that diversifying equally across managers may result in one manager unintentionally dominating the active risk profile of a portfolio. As such, one must be cognizant of not only diversifying manager risk, but what their contribution is to overall risk and how strongly they are correlated with their peers and the broader portfolio.
Active risk can be attained both through tactical out-of-benchmark investment decisions and by staying within the definition of the benchmark but varying the weights of the securities owned. While most active managers will attempt to identify or deliver alpha (i.e. risk adjusted excess returns) they fall woefully short for a variety of reasons, not the least of which is a flawed manager selection process. This process begins with a true definition of alpha. While we defined alpha as risk adjusted excess return, we left out the most important and often overlooked part of that definition. That is, alpha is risk adjusted excess returns after identifying all possible betas that exist within a portfolio. While most know beta as a risk factor related to the ups and downs of the market, in reality there are dozens, if not hundreds of betas that exist within a single portfolio. It is only after identifying each meaningful beta influence that one can truly identify alpha. This is perhaps the single most important step in portfolio construction and it is the one that is most often overlooked.
At iCM, risk management is in the truest sense of the phrase, knowing what you own. We take each dimension of portfolio risk very seriously in our effort to know what we, and you as a client, own better than anyone.
It is this depth of knowledge that is our commitment to every investor and, by virtue of this understanding, you as our client can have greater insight into how we are on your side.