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Value Architects Balanced Account Philosophy is to provide investors the opportunity to achieve long term capital appreciation in equities, while offsetting the inherent volatility of equities with the predictable income stream of fixed income. Over time our balanced portfolios should provide returns and volatility between those of a pure equity and a pure fixed income portfolio.
Asset Allocation
To pursue these objectives, we normally invest between 50 and 80% of total assets in equity securities, primarily common stocks. A minimum of 20% of total assets will be allocated to fixed-income securities, primarily bonds, at all times. Risk preferences of the individual client will determine the specific target allocation of the portfolio.
Variations in the target allocation is determined by the portfolio managers’ assessment of business, economic, and capital market conditions, and particularly by our ability to find equity securities that are “attractively” valued. Active allocation shifts between fixed income and equity portions of the balanced portfolio are assessed monthly or more frequently, depending on market conditions. A minimum shift in weighting of 5% is considered to implement a change in active asset allocation.
The central thesis of Value Architects’ approach to capital markets is to purchase equity securities whose market value is significantly below our determination of their intrinsic value. This approach, originally espoused by Benjamin Graham and later promulgated by Warren Buffet, is also known as a Margin of Safety approach. Changes in our fixed income allocations relate to the availability of equity securities that meet our margin of safety requirements, risk reduction for the overall portfolio, augmentation of portfolio income, and reduction of overall portfolio volatility.
Fixed Income Security Selection
The emphasis of security selection is credit quality and predictability of cash flows. Ordinarily, securities issued by the U.S. government and its agencies will constitute a majority of the fixed income portfolio. Mortgage-backed securities and asset-backed securities are not used because of the uncertainty in predicting their cash flows. Tax efficiency is also a primary consideration and the relative value of tax-free versus taxable securities is monitored. Should tax-free securities be used (when applicable), only investment grade or insured securities are selected.
Typically, the structure of the fixed income portfolio is achieved through laddering. Laddering involves building a portfolio of bonds with staggered maturities so that a portion of the portfolio will mature each year or every several years. To maintain the ladder, principal that comes in from currently maturing bonds is typically re-invested in bonds with longer maturities within the range of the bond ladder (ordinarily up to 10 years maturity.) The primary goal of the laddered bond portfolio structure is to achieve a total return over all interest rate cycles that compares favorably to the total return of a long-term bond, but with less market price and reinvestment risk. Such a strategy avoids the risk inherent in interest-rate anticipation strategies.
Value Architects prefers to confine business risk to the equity allocation of the total portfolio. Under exceptional circumstances, when valuation warrants, investment grade corporate fixed income securities may be purchased for up to 25% of the total fixed income allocation. Under these circumstances, overall sector and company exposure from both fixed income and equity allocations will be considered to minimize risk.
Equity Security Selection
The criteria for stock selection within the Balanced Account portfolio are identical to those of our All Cap Equity portfolios. Financial health and soundness is a primary consideration, and is generally evidenced by a history of free cash flow generation, and favorable comparison to industry returns on invested capital. Purchase of securities at a discount to our calculation of intrinsic value reduces the risk of overpaying.
Portfolios are diversified across S&P defined sectors, typically having exposure across a minimum of seven of the ten sectors. At a minimum, portfolios will contain at least twenty equity securities. Individual equity position weightings will be a minimum of 2% and a maximum of 10%.
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