Sheets Smith Investment Management
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Absolute Return Balanced Plus Portfolio

Absolute Return Balanced Plus Portfolio

 Balanced Investment Philosophy

The tactical asset allocation model used for the Absolute Balanced Plus accounts was originally developed by William F. Sharpe.  The difference in this approach from others is that the expected return for stocks is based on projected earnings rather than historical returns.  As earnings estimates change with the economic cycle and as the price of stock market changes, the expected return of the stock market also changes.  This expected return is then evaluated with the more stable investments of bonds and cash equivalent investments.  The model calculates the optimal mix at the time based on current interest rates and the historical volatility of the capital markets.  The inception date of this product is 7/1/2006.  Although the asset allocation model has a much longer history, the stock selection process used here began on this date.

Investment Decision Making Process

The decision-making process begins with the asset allocation process.  This decision as well as the stock selection process is highly quantitative.  The expected returns of stocks is derived through mathematical calculations.  This number along with the level of interest rates and the statistical measures of risk and covariances are input into the optimization model which calculates the optimal asset allocation at this time.  This process is calculated at least monthly.  The Absolute Return Balanced product, we believe, is the optimal balance between risk and return.  The firm can and does manage accounts somewhat more aggressively, but there is a corresponding increase in risk.  Conversely, the same is true for more conservative accounts.  The difference between accounts with different risk tolerances is managed through the asset allocation process, not through stock selection.  Stocks are selected for inclusion by passing several quantitative screens, the most important of these being the growth rate of earnings and the strength of earnings revisions.  Various technical measures are then evaluated.  The stocks having the best measured characteristics are included in a portfolio.

Portfolio Construction

We believe the Absolute Balanced Plus product is an ideal balance between risk and return.  The asset mix has averaged about 60% stocks, 30% bonds and 10% cash over time.  However, there have been periods of time when the portfolio has been as much as 100% stocks and as little as 20% stocks.  The change in the mix is usually gradual over time but is the primary driver of the performance of this product.  The frequency of rebalancing depends on the performance of the stocks in the portfolio and changes in the level of interest rates.  The Active Asset Allocation model dictates changes in the mix.  The decision to make changes in the mix is determined at least once per month or when significant changes occur in the capital markets.  Once the percentage of stocks is determined for the portfolio, stocks are selected by passing a computer screening process based on earnings growth, earnings revisions and various technical measures.  The portfolio is highly diversified usually consisting of about 100 stocks of all capitalizations and many industry sectors.  The screening factors determine sector emphasis.  The asset classes used in these portfolios consist of stocks publicly traded in the United States, including ADR's.  Fixed income securities are generally of intermediate maturities and may consist of Government, Agency and Corporate paper.  When appropriate, municipal bonds will be used, but those accounts are not included in the composite shown here.  Some longer term and short-term maturities will be utilized depending on anticipated changes in interest rates.

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