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:
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.
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.
- ECAM provides a weekly market
summary, monthly summary and quarterly newsletter with updated Provident fund
prices, performance and commentary.
If you would like further
information please visit us (like Joe did) at:
Or you could just go with
the “hope and prayer” process………..
