Summary

After a recent update of our forecasts for future earnings streams, we’ve decided to reduce our exposure to Small Cap stocks, which we feel are expensive relative to traditional Small Cap fundamentals (e.g., earnings and P/E multiples).  In exchange, we’re further increasing our investment in larger companies. In doing so we’re introducing an alternative investment, an “Equal-Weight” S&P 500 index fund, to our portfolios. We expect that, over time, this core holding will provide incremental return over the benchmarks while providing our clients with valuable diversification to company, sector/industry and sub-advisor exposure at a lower cost.

Highlights

Ø  We have maintained a modest “underweight” position with Small Cap stocks for some time, meaning those positions have been smaller than the weights we view as “neutral” for each strategy. We’ve favored Mid Cap stocks and Large Cap stocks instead due to their fundamentals. A neutral position is the weight we hold if all asset classes have comparable return outlooks.

Ø  In this portfolio shift, we’re moving the Small Cap position even more underweight -- down from its neutral position. After an extensive review of causal fundamental factors, we feel that even with generous allowances for earnings growth and future P/E multiples, this group of stocks is relatively expensive and likely to under-perform. Therefore we’re increasing our position in the Large Cap universe.

Ø  Since we already have large positions in a number of Large Cap managers, we’re taking this opportunity to employ an Alternative vehicle that we have studied for some time – an Equal-Weight S&P 500 index.

Ø  This is a passive investment vehicle. Although it shares the “index fund” nomenclature with traditional index funds, it weights each stock in the S&P 500 equally. This differs from traditional passive funds, which weight each stock by its market capitalization weight.

Ø  These funds charge lower fees than bottom-up security selectors and can offer superior company and sector/industry diversification. They have a track record of strong performance, including in risk-adjusted terms. Some research also indicates they perform well during challenging market periods, which we believe can offer risk mitigation in what we expect will be a moderate, uncertain recovery thanks to the global, private-sector deleveraging process.

Ø  In the Equal-Weight S&P 500 index, each stock will have approximately a 0.2% weight. For comparison, in the traditional S&P 500 index fund, the largest stock, Exxon, has a 3.45% weight as of 3/31. Traditional index funds tend to favor companies that have already succeeded, and could generate lower future returns. Although there is a place for traditional index funds in portfolios, we believe a diversified and carefully constructed portfolio can generate better risk-adjusted results.