The Traders Journal

My Methodology Allocation Beats Asset Allocation


From what I’ve seen of most investors’ asset allocations, it’s a maze.  My personal asset allocation is better described as a labyrinth.  Unlike a maze that attempts to make you mentally confused and physically lost, a labyrinth provides a path towards inner calm and mental clarity.  My labyrinth allocation is in fact more accurately described as a methodology allocation and is built upon three foundations:  diversification, correlation and methodology.  Let me explain. 

Diversification means different things to different types of investors.  In my portfolio, this plays out as a lifetime mantra of distributing assets across a very wide array of buckets – classic diversification.  Some buckets are relatively uncorrelated, while others are negatively correlated (all the time acknowledging that in times of crisis, correlations tend to rise amongst all assets).  Basically, I’ve avoided the strategy of, for example, buying a dozen rental properties in one neighborhood.  These are all correlated assets and diversification is non-existent.  My point is simple.  Avoid putting all your eggs in one basket is not just a cliché but a truism as well.  But then also make certain your eggs are somewhat uncorrelated.  

My third foundation is methodology.  Here is where I differ from the sea of asset allocators because I factor in my own personality, skills and trading style.  As a trader, I buy individual stocks based on strength, relative outperformance and momentum.  I cover this base or asset bucket myself.  I don’t look to ETFs or mutual funds to do this for me.  Conversely, as a trader, I also know myself and acknowledge that I am not emotionally capable of buying deep discounted equities or distressed securities.  Those are what asset allocators label as ‘value stocks’.   

For this reason, I call my approach the Methodology Allocation because each bucket is highly specialized with a unique investment focus, process and philosophy.  It compliments my total portfolio because it fills in those voids that I do not directly invest in myself via individual stocks.  This boutique approach allows me to seek out the best-proven investment talent in the particular niche I want covered.

I’ll use the large and mid-cap value segments as an example.  I have owned two deep value mutual funds for a long time.  Their comparative bogey is the Guggenheim S&P 500 Pure Value ETF (RPV).  An attractive fund in its own right that over the past seven years has outperformed both the S&P 500 (SPY) and the Vanguard Total Market Index (VTI) by a wide margin.  In this segment, my deep value AMG Yacktman Fund (YACKX) has significantly outperformed its bogey (RPV) over the same seven years.  My other value fund, the Sequoia Fund (SEQUX) has outperformed both YACKX and RPV over the past twenty years.  I like what they do and they can execute this methodology better than I can, so I let them do just that.

With my methodology allocation approach, the first question I ask when I’m looking at an asset class is whether I am justified in paying for active management, such as a mutual fund, or whether I am better served with a low cost passively managed index ETF.  Let me offer you a key insight here.  In certain asset classes, the active management wins.  In other asset classes, the passive ETFs win.  Performance charts that overlay many equities on one chart are powerful allies here and yield clear answers for you.

For example, in the small caps arena, I prefer the Vanguard Small Cap Vipers (VB) with its sensational low fees (0.09%) and yield (1.43%).  To best fit my needs and risk profile, I have not found a mutual fund with reasonable costs in the actively managed small cap arena that consistently outperformed the VB.  

Another example of my methodology allocation approach is the Merger Fund (MERFX) which I’ve owned in my IRA for nearly 20 years.  Its methodology focus is in the mergers-arbitrage arena, which kicks out regular consistent distributions and has a beta of 0.12, which simply means it is not correlated to the market and just marches to its own drum.  I have neither the staff nor the expertise to do what they do, so I let them do their thing on my behalf.

My final example of my methodology allocation is biotech.  I had followed Bob Swanson since he founded Genentech and spoke to us at the Stanford Business School in 1980.  I’ve made a lot of money throughout the years investing in biotech and have the burns to show as proof.  Over the years, I’ve concluded that for this particular industry, I want exposure to their wonderful creations, discoveries and equities, but I don’t have the research skill set to trade volatile individual biotech stocks.  The Market Vector Biotech ETF (BBH) is my vehicle of choice.  It’s a basket of the 25 most significant biotechs, and with its relatively modest fees (0.35%) and low turnover (11%), it’s the victor over most all actively managed mutual funds or individual equities in my book.

So, you can see that I don’t subscribe to the normal money managers’ model of classic asset allocation.  My methodology allocation leverages my individual strengths and those of both the passive and actively managed arenas of the stock market.  It’s not a maze.  It’s my very profitable personal labyrinth that allows me to maintain my inner calm and mental clarity in all types of markets.

Trade well; trade with discipline!
-- Gatis Roze


Gatis Roze
About the author: , MBA, CMT, is a veteran full-time stock market investor who has traded his own account since 1989 unburdened by the distraction of clients. He holds an MBA from the Stanford Graduate School of Business, is a past president of the Technical Securities Analysts Association (TSAA), and is a Chartered Market Technician (CMT). After several successful entrepreneurial business ventures, Gatis retired in his early 40s to focus on investing in the financial markets. With consistent success as a stock market trader, he began teaching investments at the post-college level in 2000 and continues to do so today. Learn More
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