Every investment strategy comes with its own set of risks. Here are some of what we consider to be the most important risks inherent in our process:

High turnover

  • 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.
  •  This is why these models are best suited to tactical not strategic asset allocation mandates.

Timing and valuation risk

  • The models are exposed to timing and relative valuation risks, which are different from many conventional value-based approaches.
  • We use excess volatility as one of the inputs into the process. This makes equities look “expensive” after a period of high volatility, which is often associated with falling returns.
  • On these occasions equities may look “cheap” on a conventional valuation basis.
  •  Many investors find it counter-intuitive, or just plain wrong, to avoid equities when they offer a high dividend yield or low PE ratio and then start buying only after they have started to rise.
  • 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.
  • There is of course no guarantee that equities or any other risk asset will continue to perform well once the model has rebuilt its exposure to those assets.