Investment Management

With so much information available, many individuals find that managing their investment portfolio has become too complex and challenging. Financial products are constantly changing, with new ones being introduced daily. Additionally, the financial media and “experts” are regularly debating the next great industry for investment, and unfortunately new financial schemes appear more frequently in today’s environment than at any other time in the past. It is no surprise that some investors question their confidence in the financial system and aren’t sure what to do and who to trust.

To assist our clients in developing a plan that meets their individual needs, we offer a structured, unemotional and highly diversified investment approach that provides objective advice and solutions to problems, rather than focusing on purchasing financial products.

Our investment approach is called Structured Asset Allocation. It is an approach based on the science and art of investing with decades of research guiding the way. It cuts through the “noise” and its implications, by structuring an allocation that focuses on what really drives investment return, helps to achieve more consistency, and simplifies the investment process. The principal theories of Structured Asset Allocation are not new. They are time-tested and supported by decades of empirical research.

Choose from the tabs below to learn about the elements of Structured Asset Allocation and its benefits:

• Markets Work
• Asset Allocation
• Effective Diversification
• Tax Management
• Periodic Rebalancing

The foundation of modern economics, as we know it, is that a free and competitive market is the most efficient way to allocate resources. Investment markets throughout the world have a history of compensating investors for the capital they supply.

Companies compete with each other for investment dollars, and millions of investors compete to find the most attractive returns. This competition quickly drives the market to near-instant efficiency and the prices to fair value, ensuring that no investor can expect greater returns without bearing an increased amount of risk.

With this information, we are able to conclude that with market equilibrium:

• Market prices reflect all available information and expectations
  
• Price changes reflect what investors feel a company is worth based on current events and cannot be predicted with any consistency
  
• Pricing errors – the difference between the efficient price and actual transaction price, are difficult to recognize in real time and are not predictable
  

The market may not always seem balanced and prices may not always be “accurate,” but due to competition, we believe, consistently outperforming the market has yet to happen. The idea that markets work is widely acknowledged by financial professionals, economists, and academic researchers alike. The implications of market efficiency then are profound and affect a wide variety of financial and investment decisions.

We use investment products that incorporate the following concepts in our Structured Asset Allocation approach:

• Attempt to capture market rates of return by investing in large numbers of securities in selected asset classes, resulting in portfolios that offer exposure to thousands of securities

• Exclude Initial Public Offerings, financially distressed and bankrupt companies, and illiquid securities

• Own a diverse allocation of investments and hold onto them, rather than frequently buying and selling unnecessarily
  
• Do not track indexes; this can result in significant trading costs
  
• Allow portfolio managers flexibility on when to add or remove individual securities from asset classes to account for momentum effects, trading costs, and other such factors

History shows us that investors are compensated in proportion to the risk they take, and that a diversified portfolio’s expected return is the direct result of its exposure to certain risk factors. Since we know that a portfolio’s asset allocation determines its exposure to risk factors, how to allocate is one of the most important factors in achieving successful investment results. Maxima Wealth Management will spend a significant amount of time analyzing and determining the appropriate asset allocation plan based on your personal risk factor tolerance.

Our research has identified five risk factors that we believe explain most of the expected returns associated with diversely allocated portfolios. The first three factors are related to the equity market and the last two reflect compensated risk in the fixed income market:

Market Risk — Generally, stocks have higher expected returns than fixed income securities

Size Risk – Small company stocks have higher expected returns than large company stocks

Value/Growth Risk – Lower-priced “value” stocks have higher expected returns than higher-priced “growth” stocks

Maturity Risk – Longer-term bonds are riskier than shorter-term instruments

Credit Risk – Instruments of lower credit quality are riskier than instruments of higher credit quality

Academic research shows that the degree to which a portfolio is exposed to these five risk factors determines nearly all of its risk and expected return. An advantage of Structured Asset Allocation is that rather than focusing on individual stock or bond selection, investors work to manage exposure to risk factors by investing in structured asset classes.

Diversification is an essential tool available to investors. We believe successful investing means not only capitalizing on risks that generate expected return, but also managing risks that do not. Some avoidable risks include holding too few securities, speculating on individual countries or industries, following market predictions, and relying solely on buy or sell recommendations from third-party analysts or rating services.

Diversification helps immunize your portfolio to all of these potentially damaging mistakes. Additionally, it helps minimize the random outcomes of individual securities, and positions your portfolio to capture the returns of broad economic forces.

Diversification is much more than ensuring that you don’t have all your eggs in one basket. It’s known that stocks with similar risk factors tend to move together. This can dramatically reduce the benefit of owning multiple stocks in a portfolio. For example, if a portfolio of stocks move in perfect correlation, there is little reason to own more than one. Having a portfolio of stocks that move together is what we call “ineffective diversification” because risk is not reduced.

Alternatively, “effective diversification” does help reduce risk. An effectively diversified portfolio is constructed of asset classes that do not share common risk factors and therefore tend not to move together. These portfolios create more consistent, less volatile net returns. Effective diversification should help you sleep better at night, and help your money compound at a greater rate compared to a less effectively diversified portfolio with the same average return.

1. Combine Multiple Asset Classes
   Seek to combine multiple asset classes that historically have experienced dissimilar return patterns across various financial and economic environments
   
   
2. Diversify Globally
   More than half of the market value of global equities is located outside the United States and historically, international stock markets as a whole have exhibited dissimilar return patterns to the U.S. markets
   
   
3. Invest in Thousands of Securities
   Compared to a portfolio concentrated in a small number of securities, investing in thousands of securities around the world can limit portfolio losses during a severe market decline by reducing company-specific risk
   
   
4. Invest in High-Quality, Short-Term Fixed Income
   Fixed income in a diversified portfolio is to reduce volatility, invest in short-term, high-quality securities that have a low correlation with stocks and strong credit quality

Nobody likes to pay taxes, especially on investment portfolios targeted for long-term growth. However, to the extent that tax liability is reduced, after-tax returns are increased. Tax management is a methodical approach to legally minimize a client’s tax exposure while maintaining their desired asset class exposure.

Asset Location

• The tax status of accounts is considered when choosing where to hold securities. A higher proportion of income-producing investments can be held in tax-deferred accounts (i.e. IRA); while a greater percentage of asset classes that generate capital gains may be located in taxable accounts.
  

Tax-Efficient Rebalancing

• Consider all accounts within the complete portfolio when rebalancing for more tax-efficient transactions.
  

Tax-Managed Investments

• In certain asset classes, tax-managed investments can be used to help reduce dividend and capital gain distributions. Dimensional Fund Advisors, for example, uses proprietary strategies designed by their team of academic researchers to try and minimize or eliminate short-term gains, harvest capital losses when possible, and minimize dividend yield when appropriate.
  

Maxima Wealth Management will work with a client’s personal tax advisor when evaluating the cost basis of securities sold during the year and seek opportunities to generate tax losses for clients who would benefit from them. This requires careful trading and planning to make sure that tax rules are followed correctly.

A portfolio can drift from its initial asset allocation over time due to market fluctuations, causing the portfolio’s risk and return characteristics to change. By periodically rebalancing the portfolio, the original risk profile can be more closely maintained. Additionally, there is statistical evidence that a systematic rebalanced program may increase returns over the long-term.

We meet with clients regularly to review all portfolios to determine if there is a need to rebalance. The following guidelines summarize our rebalancing philosophy:

• Rebalancing trades should only occur when the expected benefits exceed expected costs
  
• Focus on reducing the tax and transaction costs of rebalancing
  
• Review portfolios frequently for possible rebalancing opportunities
  
• An asset class must be sufficiently far from its target allocation to be considered for rebalancing