Emirates Capital Asset Management (ECAM): What is your Investment Process?

In a recent article published 21 Feb 2014 in the Washington Post, Barry Ritholtz (a well known asset manager and writer) wrote about the concept of Investment Process:

Outcome or Process-what investment focus succeeds over time?

Interestingly his article came out 2 weeks after my blog article published 09 Feb 2014 on the new ECAM website outlining the same investment theme.

Successful investment is not something that should be done by accident, sentiment, intuition, hope or prayer (which seems to be the 5 top “strategies” utilized by most Emirates pilots). Successful investment is a process-oriented endeavor and only by utilizing some sort of rational, cognizant methodology will the average investor ever hope to save enough for future retirement.

Recently I have received a number of inquires on the new ECAM site asking how the ECAM process offered could be of value to the majority of pilots. I hope the following will assist in answering that question.

We will start by taking the average Emirates pilot (age 48, wife, 3 kids, and 1 dog). We’ll call him Joe. Joe joined Emirates 10 years ago and has only recently started thinking seriously about what he should do to save and invest for his retirement (which is rapidly approaching much faster than he thought given how fast the time has flown the past 10 years he has worked for Emirates). He knows he should have started much sooner (and saved much more at this point in time) but did not. He also hopes his younger colleagues he flies with are not doing as he has done in the past and are putting more away in their savings (though he doubts this is the case).

Joe doesn't know that much about investment and, in fact, really doesn’t want to learn. He doesn't’ have the time or interested in putting in 100’s of hours of work monthly in keeping up on economics, market fundamentals, technical analysis, etc. To him working on this stuff is like watching paint dry or grass grow; B-O-R-I-N-G. He has experienced the “cold-calls” of the so-called “investment advisers ” in Dubai and wants nothing to do with having his money managed by these types.

So Joe comes to ECAM and asks what we can do to help him become a better investor. Here is what ECAM does for Joe via their Retirement Fund Analysis Service:

1) Assessment:

ECAM needs to provide Joe with an individualized foundation upon which to begin. In order to do so, ECAM provides Joe with the financial services industries most widely recognized and accepted psychometric investment risk tolerance questionnaire developed by FinaMetrica. Joe has done psychometric questionnaires before at Emirates (more than he cares to have done) and really doesn't know what this has to do with investment.

ECAM explains to Joe that in order for an individual to know the amount of risk assets they should have in their portfolio (not just the Provident Fund but all equity/pension fund investments) they need to do a self-evaluation of their unique tolerance to financial risk. When we are younger (with retirement many years away) we tend to be more risk-tolerant than we are when we are older and closer to retirement. The degree to which you as an individual are prepared to tolerate that financial risk can be measured.

Joe goes ahead and completes the 25 question risk tolerance questionnaire. Once completed Joe learns he has been psychometrically assessed as having a unique risk tolerance score of 58 (out of 100).

Joe consults the FinaMetrica Risk Tolerance Grouping and sees his score of 58 falls into Group 5 of the 7 Risk Groups. Joe also learns that based upon his Risk Group his “ideal” target for Growth Assets (equities) is 64%. Joe also sees there is an acceptable growth asset band around this ideal of 54%-73%.

So what has Joe learned? Joe now knows based upon his unique circumstances in life (age, investment knowledge/experience, assets, liabilities, responsibilities, etc) his ideal “sleep soundly at night” equity exposure band is 54%-73% with the “ideal” at 64%. If Joe exceeds this upper limit and the market experiences a sudden unexpected decline Joe may panic and sell into the bottom (he certainly won't be sleeping well). Alternately, if Joe has been keeping his money in cash or under-invested (a "guaranteed" loss due to account management fees and inflation), he now knows given his unique makeup he should have at least 54% of his assets in growth assets (equities) to provide sufficient protection from inflation yet still keep him sleeping soundly.

2) Portfolio Tilt:

Joe is now deciding how much of his band (his ideal is 64% with a band of 54%-73%) he should have in equities as the market is seldom “ideal”. Joe consults the ECAM 4-Factor Model Portfolio Risk Adjustment model to answer the question.

The ECAM 4-Factor Model Portfolio Risk Adjustment model utilizes 4 proprietary models to analyze risk. The 4 models are:

Economic Model (monetary conditions, economic conditions and inflation)
Fundamental Model (valuation)
Technical Model (trend and momentum)
Sentiment Model (degree of bullishness)

Each of the models incorporates a large number of inputs to ensure a single data point does not skew the model output. The results are compiled into a single ECAM 4-Factor Composite Model depicted as a stoplight for clarity:

Red: market conditions are hazardous
Yellow: market conditions are neutral
Green: market conditions are favorable

Utilizing the results of the Composite model, ECAM adjusts the FinaMetrica model portfolios for actual market conditions. When market conditions are favorable, the adjusted model tilts towards the upper limit of the growth asset band (in Joe’s case; this would be 73% equity exposure). When market conditions are neutral, the model maintains the “ideal” growth asset allocation (in Joe’s case, this would be 64% equity exposure). When market conditions are hazardous, the model tilts towards the lower limit of the growth assets allocation band (in Joe’s case, this would be 54% equity exposure).

Joe now knows (through self-assessment and without the use of a high price “adviser” who tends to care more about himself than his client) what his personal risk tolerance is and, based upon current market conditions, what his equity exposure should be at any given point in time.

3) Equity Cut-off Switch

Built into the ECAM model is a proprietary “equity cutoff switch”. The purpose of this switch is to determine when there is a high probability of a bear market decline. During such times having exposure to equity assets can be very hazardous to your financial health (a 50% loss requires a 100% gain to get back to even).

It is the ultimate goal of ECAM to deliver absolute returns over compete market cycles. As such, when the model indicates a high probability of a bear market decline, all risk group models are moved 100% into cash in their respective risk-adjusted equity allocations. In other words, Joe knows at some point in the future (as the next bear market is sensed) the ECAM models will recommend a move of the equity portion of his account (the top band being 73%) into cash.

Once the bear market is assessed to be completed, the model will rotate in the same manner (in Joe’s case it would rotate back into a 73% equity exposure).

Questions:

Joe wonders how often switches would need to be made given the illiquid and difficult nature of completing switches in the Provident Fund.

Historically market conditions change slowly. As such, Joe would only need to consider a re-balance of his account once per quarter. This should be sufficient to keep Joe’s equity allocations between his ideal bands and also not exceed the maximum switches authorized by Emirates. Joe also knows that if/when the ECAM model portfolio cut off swith is activated he will receive an email advising him of such immediately.

Joe wonders how he could complete a switch if he doesn’t want to use the Watson Wyatt (now known as Towers Watson) website.

Joe finds all the switching forms are in PDF format on the ECAM website. He can fill them out and fax them to Emirates for them to complete the switch on his behalf (if Emirates gets the form before 10:00 am local time the switch is made the same day at that day’s closing price).

Joe would like more information on the funds offered in the A/B/C accounts. When he goes to the Watson Wyatt website he finds very outdated fund fact sheets and very little information on the various fund offerings.

Joe learns ECAM has provided links for every fund in the A/B/C accounts to the best possible information resource (currently about 95% have access to Morningstar). Once he has clicked on the link, he can review a ton of data on the fund compiled my Morningstar (performance, holdings, graphs, fact sheets, etc).

Joe would like to get some updates on current market conditions.