CR,
The best way to keep up with my columns is on this website, www.assetbuilder.com, where we post columns Wednesday and Friday. The site also has an archive going back more than 10 years and a good search engine--- so you can see what's been written earlier. This site also has reader forums where I answer questions--- more than 800 so far--- so it's got an added dimension.
We talked through your question very, very carefully before deciding to go ahead with AssetBuilder.
In an ideal world everyone would love investing and would enjoy managing their money using inexpensive index funds. That's what I've been writing about for literal decades.
But the reality is that many people like the idea of low cost investing but don't actually make the time to do the chores. Worse, they may fail to rebalance or find themselves swayed by the talking heads. As a result they may buy or sell rather than holding an asset allocation that provides the level of risk and expected return they seek. Others like the idea of low-cost index investing. But they would rather someone did it for them and are willing to pay for the service.
Because of this, the first question we asked ourselves was: How can we add value that most do-it-yourself investors can't do? Can we do this at a price level that will shake the foundations of the legacy distribution system and its excessive, value-destroying fees?
The answer to the second question is easy. With fees that range from 45 down to 25 basis points, few advisory firms can get in the ring. We figure that every dollar of revenue we gain takes three to four dollars out of the legacy system and puts the 2 to 3 dollar difference back in investors pockets.
The answer to the first question is very positive, but more complicated. So please bear with me.
The Couch Potato Building Block portfolios are remarkably cost-efficient. But they are not particularly risk-efficient. They have a limited range of equity holdings (50 percent to 80 percent) and the asset allocation is driven by simplicity rather than considerations of correlation. We felt we could add value-by using mean variance optimization to build a spectrum of risk-efficient index portfolios.
As a consequence, you can select an AssetBuilder portfolio that has significantly less risk than any of the Couch Potato Building Block portfolios. In addition, our portfolios should provide investors with a nice return premium over a similar risk Couch Potato Building Block portfolio. You can explore this for yourself by comparing the returns of similar risk CP portfolios with AB portfolios. We publish the performance results for both every month at:
http://assetbuilder.com/Investing/inv_potato.aspx
The results for May 2008, for instance, show that the trailing return and risk on the Six Ways from Sunday Couch Potato portfolio (one of my favorites) from July 1, 2000 was 10.67 percent and 9.41 percent standard deviation. During the same period, AssetBuilder portfolio 10 had a standard deviation of 9.63 and a return of 11.80 percent. So our risk-efficient model portfolio had a return advantage of about 1 percentage point. That's value added. More important, the value added exceeds the price charged.
Now suppose you had gone all out with the 10 Speed Couch Potato portfolio over the same period. Your annualized return would have been 10.20 percent and your standard deviation would have been 12.04 percent.
During the same period AssetBuilder Portfolio 12 returned 13.57 percent with a standard deviation of 11.73. That's a return advantage of 3.37 percent annually for slightly less risk.
AssetBuilder Portfolio 13 returned 13.89 percent with a standard deviation of 12.37. That's a return advantage of 3.67 percent for slightly more risk. Either way, the risk-efficient portfolio comes in ahead. The cost for providing the service is a fraction of the return gained.
Now lets go a direction more and more people are favoring in these miserable bear market days--- less risk. The lowest risk Couch Potato portfolio is the original two piece Couch Potato. From July 1, 2000 to the end of May 2008, this portfolio returned 5.00 percent with a standard deviation of 6.67 percent.
What does AssetBuilder have to offer? Answer: Three of our model portfolios have the same or less risk--- but higher returns.
AB Portfolio 06 returned 7.90 percent with a standard deviation of only 4.13 percent.
AB Portfolio 07 returned 8.83 percent with a standard deviation of only 5.40 percent.
AB Portfolio 08 returned 9.60 percent with a standard deviation of only 6.76 percent.
So you got 2.90 percent a year of additional return with far less risk up to 4.60 percent a year of additional return at about the same risk.
That's what you can do by being risk-efficient as well as cost-efficient. We think it's well worth the 45 to 25 basis points our investors are asked to pay.
Finally, I'd like to say a few things about the tool we use---mean variance optimization. I've seen a lot of claims for it over the last 15 years. But it is important to remember that it is a concept, not a location. What we can do is fiddle with holding limits for different asset classes and hope that our portfolios deliver some portion of the risk-efficiency that the concept offers. We'll never get it perfectly. But we hope that we'll provide some additional return for any given amount of risk.
Scott
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