This report is specifically written to monitor the two long-only, equal-weighted, multi-factor model portfolios that we proposed in our 2018 Economic and Market Outlook. We expect in the long-term these portfolios would offer investors potentially superior investment return with lower corresponding risk. Our model portfolios follow a bottom-up investment approach through the adoption of various investment styles.
The first portfolio was called Dividend Focused model portfolio which consists of 22 stocks that currently and have consistently paid dividends in the past four year regardless of their historical dividend yield or dividend growth rate. Dividend paying companies usually have a proven long-term record of stability, growth, and profitability. Therefore, owning their stocks would provide investors some sort of emotional stability during market turmoil.
In addition to dividend, we also used other analytical frameworks such as price momentum, to ensure that we only buy stocks that have performed well in the past and valuation multiple (P/B) to avoid buying overpriced stocks. The Dividend Focused model portfolio is passively managed as adjustment is made once a year. The next adjustment would take place in December 2018.
The second portfolio was called Low Volatility Equities (LOVE) model portfolio, a collection of 16 stocks that have low 60-day historical volatility. Adjustments are made every three month as volatility varies with time.
The goal is to deliver expected returns that are competitive with the capitalization-weighted index, but with much lower risk. This stands in sharp contrast with traditional active portfolio management where the portfolio manager attempts to deliver superior returns while taking approximately as much risk as the capitalization-weighted index.
The Risk-Return profile of Low Volatility strategy resonates with many investors, who feel unable to bear large losses. The Low Volatility strategy may be particularly well-suited to investors who have longer investment horizons and a particular need for capital preservation.
Note that the volatility of an all-equity portfolio is still relatively higher compared to volatility of other asset classes. It is wise to mix cash or bonds with equities in a portfolio to achieve the actual low volatility. In short, we essentially focus on risk reduction by selecting stocks with greater return potential due to their characteristics (less volatile, quality, and high price momentum).