We believe the performance of nearly all successful managers and products, which is not attributed to luck, is explained by a combination of three sustainable structural qualities.
The integration of all three structural qualities within each asset class reduces the need for many portfolio solutions, each designed to match a narrow risk profile.
The objective of EDM is to create portfolios that are neutral towards mispricing.
The objective of EBRP is to properly capture relevant risk premiums that are related to each asset class and to the asset allocation process.
The objective of SED is to reduce the performance drain resulting from bad risks, to improve the efficiency of the rebalancing process and to help manage the consequences of market dislocations.
Each quality is related to a form of diversification. IPSOL CAPITAL combines all the sustainable qualities within integrated processes. This is our core philosophy.
IPSOL CAPITAL's approach leads to highly diversified portfolios that look familiar but are greatly more efficient. It allows us to manage products:
- at the single security/contract level or at the index (sector, country, etc.) level
- to manage single asset class or global balanced portfolio
- to manage long only or long/short portfolios
- to handle portfolios having dozens or hundreds of components
- to deliver high information ratios with no or limited leverage
Since all of our products uphold the same philosophy, the objectives and constraints of investors are the main factors that differentiate IPSOL CAPITAL's products.
EFFICIENT DIVERSIFICATION OF MISPRICING (EDM)
Market Price = Fundamental Value + Mispricing (+ or -)
(Known) (Unknown) (Unknown)
We do not know the fundamental value of any asset but in an index of hundreds of securities, it is reasonable to assume that half the securities are overpriced (underpriced) against the median level of mispricing (which is unknown).
Rational investors should want their portfolio to be at least neutral towards mispricing. If portfolios were truly neutral, approximately half the securities that are overvalued (undervalued) would be overweighted (underweighted).
However, in CAP weighted indices all the securities that are relatively overvalued (undervalued) are overweighted (underweighted) because we use the price itself to determine the weight of a security in such indices.
EDM turns a 100% correlation between overvaluation/ undervaluation and overweighting/ underweighting into a near 0% correlation while maintaining a balanced exposure. It partially explains why the following portfolios usually outperform in the long term: equal weights, random allocations, allocations based on accounting measures such as book value, etc. It also partially explains why benchmark agnostic managers outperform on average.
EFFICIENT BALANCE OF RISK PREMIUMS (EBRP)
Excess Return = Market Risk Premium + Asset Specific Risk Premiums + Noise
The concept of risk premiums refers to sources of returns that are rational compensation for risk. This stands in contrast to mispricing (EDM), which are sources of returns caused by behavioral factors and do not necessarily reflect higher risk. To integrate risk premiums in our approach, we need to address three issues:
- Assemble relevant risk premiums in a simple and efficient way.
- Use methodologies that capture the time varying nature of these risk premiums.
- Consider our ability to predict returns varies with the investment horizon.
For this purpose, we must use efficient methodologies that capture the time varying nature of risk premiums and consider our ability to predict them at specific horizons.
EBRP partially explains why the following styles usually outperform in the long term: value, momentum, equal risk premia, etc.
STATISTICALLY EFFICIENT DIVERSIFICATION (SED)
Long Term Compounded Return = Average Periodic Return – Bad Risks
Bad risks, such as volatility and negative asymmetry, drain the compounded return of a portfolio and its final wealth. It is a mathematical reality, not a forecast.
This does not mean that a low volatility portfolio will necessarily outperform a high volatility portfolio, but that a high volatility portfolio must overcome a greater performance drag to outperform.
Furthermore, portfolios that are well diversified also increase the efficiency of the rebalancing process and its impact on compounded returns by allowing the portfolios to benefit from momentum and market cycles. Such portfolios are also more likely to sustain less significant losses during severe crises.
SED partially explains why the following portfolios usually outperforms in the long term: lower volatility, equal risk, maximum diversification, etc.
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