Asset Allocation portfolio
It’s all about diversification
While there is no such thing as a free lunch, risk reduction through diversification is as close as it gets.
Diversification is about buying a basket of securities that tend to do well (or poorly) at different times and under different economic conditions. Being thoughtful about how much capital to allocate to each of these securities can result in far more consistent returns than concentrating all capital (and risk) in a single security or asset class. This portfolio is diversified across multiple asset classes, including stocks, bonds, and inflation-hedging securities like Real Estate Investment Trusts. The capital allocation to each of these asset classes is dialed up or down depending on the desired risk level. When these asset classes are combined together intelligently in a portfolio they can provide income, growth, and stability during different economic conditions.
Traditionally, it is well accepted in the industry that:
- stocks do well in periods of growth;
- bonds provide stability and income during periods of market downturns; and
- commodities, real estate and inflation-protected bonds do well during inflationary periods.
Our allocation
Our portfolio allocates capital to an equity component, a bond component and an inflation-hedging component. Together these deliver good diversification, which leads to risk reduction and return stability.
The capital allocation to each of these asset classes is dialed up or down depending on the targeted risk level. Clients fill out a risk questionnaire, and receive a recommended portfolio based on their responses to that risk.
Capital allocation is based on a blend of art and science. Having too much reliance on historical data is dangerous. During periods of crisis like 2008, we saw that historical correlations broke down and asset classes started moving in tandem. Relying too heavily on statistical computations involving the historical covariance matrix and forecasted expected returns would result in portfolio weights that are highly sensitive to inputs, unstable and concentrated, high turnover portfolios.
Instead we use a approach that is guided by the work done by nobel laureate William Sharpe (1964). Sharpe built on the work of Harry Markowitz (1952) - the founder of Modern Portfolio Theory or MPT - who had earlier shown that it was important to consider portfolio return in conjunction with portfolio risk, and proved the optimality of the market portfolio in terms of maximizing return for a given level of risk.
Our baseline scenario is that a passive investor holds the Global Market Portfolio (GMP) in the absence of overriding views or predictions. The global portfolio is determined by the aggregated global capital (see figure below) allocated to these asset classes. This allocation represents how important these asset classes are in meeting the financial objectives of a passive investor. Final allocations depend on the constitution of the market portfolio, and the desired level of portfolio risk. While our portfolio is passive, we employ a flexible Black-Litterman approach to portfolio construction, where we retain the flexibility to employ advisor views as an overlay to our passive allocation.
Final allocations depend on the targeted level of risk, your customization and whether the capital is held in a tax-advantaged account like an IRA.
How we build the equity component
Exposure to US stocks is obtained through the purchase of Large, Dividend, Mid and Small stocks, using best-of-class ETFs, factoring in both management fees and liquidity. Broad market indices are concentrated in mega-cap and large-cap names. To reduce this size concentration risk, we also include small and mid-cap ETFs. We include Dividend stocks since they provide exposure to both income and growth.
Exposure to foreign stocks is important for additional diversification. It is obtained through the purchase of a Developed Market stocks ETF and Emerging Market stocks ETF.
For the ESG aspect, we continue to factor in size and cost alongside the ESG criteria in selecting appropriate ETFs.
How we build the bond component
Bonds have an important role in any asset allocation portfolio since they provide stable income, have low relative volatility and provide a useful hedge against market downturns. That being said, they do carry interest rate risk, and prices may go down when there are unexpected changes in rates.
This portfolio’s exposure to bonds is built using multiple ETFs. They include low-yielding government bonds, investment-grade and high-yielding corporate bonds, tax-sensitive municipal bonds, inflation-protected and international bonds. Muni bonds are included since interest income from municipal bonds is exempt from federal taxes, so they are attractive to clients who are in high-tax brackets. High-yield bonds can be a source of attractive yield, especially in a low interest rate environment. Including International bonds adds additional diversification.
How we build the inflation hedging component
Exposure to the inflation hedging component is obtained through a mix of Commodities and Real Estate. We also allocate capital to inflation-protected bonds. These asset classes tend to provide protection during inflationary periods, and are an important part of a diversified portfolio.
How you can customize
If you have an opinion that you want taken into consideration, there is the ability to customize. You can adjust the target allocations of the ETF components that make up the Asset Allocation portfolio by changing the weights. You can also add tilt to your portfolio by including sector and thematic ETFs. We offer a range of ETFs from sectors like biotech, basic materials, industrials, consumer cyclicals, consumer non-cyclicals, financials, healthcare, technology and utilities. There is a permissible range for each ETF component, protected by guardrails. This is so your overall investment stays diversified.
You can also specify the level of ESG focus for the portfolio. A focus of 0% will result in your portfolio being composed of standard non-ESG-focused ETFs, while a focus of 100% will result in a subset of the ETFs being completely replaced by ESG-focused ETFs that provide similar asset class exposure. A partial ESG focus of 25%, 50% or 75% will result in a partial replacement of a subset of standard ETFs with ESG-focused ETFs.
How you can Tax-loss harvest (TLH)
Interactive Advisors has developed a TLH algorithm that is available to all clients who are invested in our taxable custom Asset Allocation portfolio. Clients who wish to avail of tax-loss harvesting in their taxable accounts may choose to opt in to the TLH program.
Activating the TLH algorithm is a way to potentially increase your after-tax returns by selling investments
that have
declined in value and replacing them with similar investments. The realized tax losses can potentially lower
your end
tax bill, and be reinvested in your investment portfolio.
Learn more
What makes our Asset Allocation portfolio different?
The Asset Allocation portfolio allows customers to get exposure to a diversified multi-asset portfolio at low cost.
Low management fees
We charge an asset-based management fee of 0.20%.
- There are no trading commissions, entry or exit fees.
- The minimum investment is $100.
- Please note, investors will incur fees charged by the issuers of the ETFs making up this portfolio.
Diversified asset allocation
By accessing a wider and more granular range our Asset Allocation portfolio provides diversification both across and within asset classes:
Stocks:
- Market-capitalization: Large, Mid and Small cap stocks
- Geography: US, Developed and Emerging market stocks
- Income generation: Dividend stocks
Bonds:
- Geography: US and International bonds
- Issuer: Government, Municipal and Corporate debt
- Quality: High-grade and Low-grade debt
Inflation-hedging securities:
- Security types: Real Estate Investment Trusts, Treasury Inflation-Protected Securities and Energy Resources
Fractional shares
Using fractional shares of ETFs, our Asset Allocation portfolio leads to better capital allocation and keeps cash holdings at a low level.
Important information
Nothing on this page should be construed as a solicitation or offer or recommendation to buy or sell any security or as an attempt to provide any investment advice. Investment advice is only provided to investors who become clients pursuant to an investment management agreement. Covestor Ltd is an investment advisor registered with the Securities and Exchange Commission, doing business as Interactive Advisors (“Interactive Advisors”).
Diversification of assets (which Interactive Advisors uses to reduce the risk of investment in this portfolio) does not ensure a profit or protect against investment loss. All investments, including those in this portfolio, involve the risk of loss, including possible loss of the money invested and a reduction in earnings. Market fluctuations and other factors may cause decreases in the value of client accounts invested in this portfolio. Interactive Advisors does not guarantee that any particular Asset Allocation portfolio will meet a given client’s investment objective or provide a client with a specified level of income. Past performance is no guarantee of future returns. This portfolio mainly invests in ETFs and stocks and may not be suitable for all investors. Clients may lose all or part of their investments in this portfolio.
Detailed information on the asset class risks, conflicts of interest, applicable brokerage commissions, fractional shares, and limitations on investments and divestments associated with this portfolio (along with Interactive Advisors full disclosures) is provided on the Forms and Agreements page. Additional information on the performance, composition and construction process for this portfolio may be found on Asset Allocation portfolio page.
Interactive Advisors Asset Allocation portfolio is made up of whole and/or fractional holdings of ETFs and in certain cases, individual stocks. They are not ETFs or Mutual Funds. Clients choosing to invest in this portfolio directly own the individual stocks and/or ETF shares making up the portfolio.
Interactive Advisors manages this portfolio by trading its own funds and replicating this trading in the accounts of investing clients. Clients may restrict any of the stocks or ETFs traded in their account but should note that any restrictions they place on their investments could affect the performance of their account leading it to perform differently, i.e., worse or better, than Interactive Advisors account managing the portfolio or other client accounts invested in the same portfolio.