Risk Factors

Increased turnover

Every investment strategy comes with its own set of risks. The PRATER process requires rebalancing on a weekly basis and has higher turnover than conventional portfolios. A simple two asset model will typically turn over 70% of net assets a year. A model with five asset classes may turn over 300% a year. Increased turnover will clearly lead to increased operational risk. In our opinion the extra returns are worth it, but investors need to be forewarned.

Portfolio concentration

From time to time the models may become heavily concentrated in one asset class. This may contravene the terms of an investor’s mandate or internal guidelines. We stress that the only reason for this level of concentration is that the asset has the best return per unit of risk available at the time. However investors need to be aware of this. This is why these models are best suited to tactical not strategic asset allocation mandates.

Why we use excess volatility to adjust for risk

Tactical asset allocation models need to be grounded in current market conditions. Using excess volatility as our proxy for the equity risk premium is a good way of achieving this. It tends to make equities look “expensive” after a period of high volatility, which is often associated with falling returns, when they may look “cheap” on a conventional valuation basis. Many investors find this counter-intuitive or just plain wrong. The point they often miss, is that while equities have been getting “cheaper”, bonds have probably been getting “more expensive” – i.e. producing positive returns with relatively low risk.