Investment Philosophy
Maas Capital specializes in the design and effective management of asset class investment strategies for individual investors and retirement plan sponsors.
Our investment philosophy is based on asset class investing, recognizing that investment returns are determined principally by asset allocation and not by market timing or stock picking.
An essential element of Maas Capital’s role as your investment advisor is to design a portfolio investment strategy that maximizes the likelihood of achieving your goals and objectives. This strategy will include the most appropriate combination of asset classes for your unique circumstances, risk tolerance and time horizon, and is implemented via the use of low-cost institutional index funds usually available only to large institutional investors.
Asset class investing is demonstrably successful and the most prudent way to invest our clients’ money. In a world where most investors are guessing which actively-managed mutual funds or independent money managers will out-perform, we believe that our consistent philosophy – backed by rigorous academic research and the best technology – is a clear advantage.
In developing our portfolio investment strategies for clients, we primarily utilize the passively-managed mutual funds managed by Dimensional Fund Advisors ("DFA").
Understanding Asset Class Investing
Asset class investing is best explained within the framework of today’s investment management world, which can be divided into two broad categories, each reflecting a fundamentally different philosophy regarding how modern capital markets behave. These two schools of thought are generally referred to as active and passive.
Active management is the traditional way of building a stock portfolio, and includes a wide variety of strategies for identifying companies believed to offer above-average prospects. Regardless of their individual approach, all active managers selectively purchase securities, based on some forecast of future events.
In contrast, passive – or index – management makes no forecasts of the stock market or the economy, and no effort to distinguish "attractive" from "unattractive" securities. Portfolio adjustments are made only in response to changes in the underlying benchmark, or index.
Asset classes are groups of securities with similar risk and return characteristics, e.g., large company stocks, small company stocks, value stocks, growth stocks, US government bonds, real estate. For most asset classes there are long time series of historical data that allows us to form reliable estimates of their risk and how closely the behavior of that class correlates with the behavior of other classes.
Correlation is a measurement of the extent to which two variables move together over time. Combining assets which have a relatively low positive correlation – or are even negatively correlated – makes it possible to increase the overall return of a portfolio while at the same time reducing its risk. In contrast, assets which have a very high or perfect positive correlation (i.e., those that move in lock-step with each other) have little or no benefit as a diversification tool.
An asset allocation is the most appropriate mix of asset classes for an investor, given their risk tolerance, time horizon, goals and objectives, and other unique circumstances. Once an initial asset allocation has been established and implemented, it is maintained via periodic rebalancing, and amended as appropriate (e.g., when client objectives or circumstances change).
Passively-managed index funds are the most style-consistent, cost-effective and prudent method to invest in asset classes.
Investing With Index Funds
Index funds were first launched in the early 1970s. The motivation for indexing was the poor performance of what might be called "conventional" active management – the attempt to "beat the market" by market timing and stock selection. Before the mid 1960s, there was neither a generally accepted way to calculate a total return or to compare the returns of different funds. This all changed with the advent of computers and the collection of data for mutual funds as well as individual stocks and bonds. For the first time, investors could calculate returns on a consistent basis and compare their returns with the returns achieved elsewhere. And for the first time, they became aware of the poor performance of professional money managers.
There is now over 30 years of extensive empirical research into fund performance, covering a span of over 50 years. The research is clear – in every time period examined, active management generates lower returns than would be expected from index funds. And the results are the same for all equity styles (large and small cap, growth and value).
Today, there is over $2.0 trillion invested in index funds worldwide, and the amount continues to grow steadily.
Asset Classes & Portfolio Performance
Most index funds are designed to track the performance of established "market" benchmarks, such as the S&P 500 (large US company stocks) or the Wilshire 5000 (all US company stocks).
Although such indexes have consistently generated results superior to those of actively-managed funds and independent money managers, it is important to recognize that many popular indexes were developed as simple indicators of financial performance, and were not intended to serve as blueprints for actual investment strategies.
Indeed, selecting the appropriate index funds and the most appropriate mix of the funds is critical, since a portfolio’s asset mix is the single most important determinant of its performance. Financial economic research has shown that the asset allocation decision explains approximately 95% of the variation between portfolio returns. In contrast, active efforts to "beat the market" – such as market timing or stock picking – tend to have a negative impact over time.
There are three primary "factors" which influence portfolio returns:
- the percentage invested in stocks overall (the "market" factor)
- the percentage invested in large company versus small company stocks (the "size" factor), and
- the percentage invested in "growth" versus "value" stocks (the "value" factor)
It is important to understand how this information is used to develop an appropriate asset allocation for your portfolio, using index funds that capture asset class "risk premiums" better than funds based on popular market benchmarks.
Most investors intuitively understand that small company stocks are riskier, in general, than large company stocks. It is less intuitive, however, to recognize that value stocks are riskier than growth stocks. Most investors would agree that the stocks of companies with slower earnings growth, lower product market share, questionable management and other challenges (i.e., distressed or "value" stocks) are riskier than companies with positive earnings projections, strong market positions, solid management and rosier prospects (growth stocks). As a result, value stocks sell at lower prices than growth stocks. A lower price translates into a higher cost-of-capital for these companies, which, in turn, translates into a higher expected return to their investors. Growth company stocks generally sell at much higher prices on average, have a lower cost of capital, and thus generate a lower return on capital for their investors.
These two identified risk premiums – size (large versus small cap) and value (growth versus value) – are consistent with the risk/return relationship as seen in the charts above and below.
Advantages of Asset Class Investment Stratigies
There are a number of very practical advantages to asset class investing via index funds.
Planning
As noted previously, available historical data allows us to form reliable estimates of the risk and correlation of most asset classes. An investment advisor can therefore estimate the risk of different combinations of asset categories and find the overall portfolio strategy that best suits the client’s circumstances and risk tolerance. The advisor can then form a long-run investment plan, which can be implemented exactly by investing in those same asset classes via passively-managed funds.
In contrast, actively-managed portfolios seldom bear a reliable relation to any asset class. It is generally difficult to estimate future risk levels of actively-managed portfolios, or to know how an active portfolio will relate to various asset classes in the future because such portfolios may experience radical shifts in their strategy. Thus, it is nearly impossible to engage in or implement long-range planning if the tools are actively-managed portfolios.
Performance
Actively-managed funds and active managers consistently fail to out-perform unmanaged indexes. From time to time a few active managers may appear to have the ability to "beat the market". However, it is very difficult to determine whether their success is attributable to luck or skill, since the long-time series of data needed to do so is generally not available, and it is impossible to identify them in advance.
Cost
The expense ratios for actively-managed funds are significantly higher than those of index funds. Active managers periodically reshuffle their portfolios in an effort to keep them stocked with only the most promising securities. The costs associated with generating and implementing these revisions make active management the most expensive investment approach. These expenses are passed along to the client.
Tax-Efficiency
Index funds are more tax-efficient than actively-managed funds. This is primarily due to lower portfolio turnover (less buying and selling) – index fund managers generally only make portfolio adjustments in response to changes in the underlying benchmark. As a result, indexed portfolios generally have relatively higher after-tax returns.
A few fund companies – like DFA – have taken the goal of tax efficiency further. Since value funds tend to have higher dividend yields, and both value and small cap index funds incur higher turnover than S&P 500 or "total market" index funds, certain techniques can be employed to minimize taxable distributions to mutual fund investors. Special "tax-managed" mutual funds have been developed as a result.
Implementing Asset Class Investment Stratigies
Once an investor understands and accepts the virtues and benefits of asset class investing, implementing an investment strategy is relatively straight-forward.
First, an in-depth review and analysis is made of the client’s goals and objectives, risk tolerance, investment time horizon, and any other unique circumstances.
Then, the risk and return characteristics of individual asset classes and combinations of asset classes are explained, and an appropriate asset allocation is selected. One of the unique benefits of index investing is that it permits the accurate review of historical performance of various asset class combinations. As such, it is possible to see how a portfolio with a desired asset allocation would have performed during any historical period – say, the bear market of the early 1970s, the bull market of the late 1990s, or the recent market downturn. This is simply not possible with actively-managed portfolios.
We then implement the desired asset allocation in the most cost-effective and tax-efficient manner possible, generally using very low-cost index funds usually only available to large institutional investors.
Maas Capital follows a strict buy-and-hold discipline. However, because asset class returns invariably fluctuate over time, the composition of a portfolio will also change. If these movements are large enough – up or down – the risk and return characteristics can be adversely affected, and rebalancing is needed to restore the portfolio to its desired balance. This is often very difficult for investors to do on their own, since there is a natural reluctance to sell "winners" and buy "losers". However, this "buy low and sell high" discipline can enhance portfolio returns without having to resort to the damaging market timing behavior associated with predicting future market movements.
Maas Capital uses customized portfolio management software to track current versus target asset allocations, and we make rebalancing recommendations when appropriate (taking into account transaction costs and tax consequences).
We also report portfolio holdings, changes in the account(s), and the progress of the portfolio on a quarterly basis. These reports complement and enhance the monthly reports clients receive from their custodian (e.g., Fidelity).
Finally, we communicate with clients regularly via meetings, phone calls, email, and postings to our website, to reinforce the principles of asset class investing.