CaMDAR® Model – How to Be the Market
What is the CaMDAR® Model?
CaMDAR® is an acronym for Client and Market Dynamic Age-based Rebalancing. It is a Financial Investing Model that is used to invest client’s funds in Exchange Traded Funds (ETFs) based on client attributes and market attributes that change over time. It uses the client’s “chronological age” as a starting point but adjusts the chronological age based on external market and client specific factors to arrive at an “investment age”. A portfolio of diversified ETFs is determined based on the investment age. The model is designed to be rebalanced periodically. The model’s objective is to provide the client with near market results with limited fees and expenses.
Global Investment Options
When it comes to investing, your strategy may come down to 3 choices:
Option 1 - Trying to “Beat” the market by personally evaluating stocks and choosing what you think will outperform. Knowing that due to the normally fewer number of stocks you can successfully analyze will result in holdings with higher risk but also a potential for higher rewards.
Option 2 - Trying to “Beat” the market by allowing someone else to evaluate the stocks for some type of fee and then hope that what you paid for the service will pay for itself via higher returns. You gain more diversification but add additional expense.
Option 3 - Try to “Be” the market through diversification hopefully at a lower cost.
Discussion on Investment Options
Option 1 Discussion – Many people do not have the time, data, and intelligence to attempt option 1 there are some that could. The marketplace can be very efficient. As information comes available about a stock or bond, those analysts who may spend full time studying the company and working with its ownership, may have an advance knowledge, even if it is mere seconds. While some have made great returns with this approach, others have failed. Relating this to playing poker; one may view him or herself as a good amateur poker player and when playing against friends and family may do well. However, if this person plays heads-up against professional players, sooner or later, they are likely to lose, not to mention that the house takes it cut just a as a brokerage house may charge for transactions. For some, this may be a good approach for a small portion of their funds. They can carve out a small portion and use this approach as a speculative investment. It keeps you interested in the market, you can have fun with it, and may do well without risking your retirement. If over time, you find that you are successful, you can add a bit more. But as you add more, one should consider further diversification.
Option 2 Discussion – Many people invest this way today. Whether they are putting their money into mutual funds, or they have an investment professional recommending purchases, these investors are paying some type of fee in hopes that what their professionals purchase will be able to beat the market by more than the cost of the service. The trouble is that statistically, a vast majority Mutual Fund Managers do not beat their benchmarks over an extended period. According to the 2014 Investment Company Fact Book, between 2003 and 2013 only 19% of the mutual funds survived and beat their benchmark. Returning to our analysis of the poker player; if we have a poker professional and put him in a room with 6 other poker professionals of equal caliber, because the house takes a cut of each pot, one would expect most, if not all would be have less at the end of a year. Remember, in today’s market, when some smart fund manager or stock picker decides that he should sell XYZ company at a given price, the person on the other side of the trade who feels he should buy XYZ at that same price (or a little more due to the bid/ask spread) could very well be another very smart fund manager or stock picker. Nevertheless, there are Fund managers that have been successful beating their benchmarks. Like with option 1, if one does their homework, they may be able to find funds that could potentially provide returns that offset the increased expense cost.
Option 3 - There has been a growing trend of those wanting to “be” the market rather than trying to “beat” the market. Under this approach, an investor purchases index funds or ETFs that reflect a market or market segment. But do so at a potentially low cost. The savings may not be large in percentage terms but remember that in long term investing, a small change in annual return can have large long term impacts. For example, a 25 year old starting at a $30,000 salary who gets an average salary increase of 3.5% annually and invests 10% of salary for retirement, if he can move a rate of return from 7% annually to 7.5% (a change of ½ a percent – or 50 basis points) annually, this is over $225,000 by the time he is 70. A downside to this is that there is a fee paid to the person managing the portfolio mix. The investor using this option hopes that the s fee charged by the portfolio manager is lower than the fee of the fund manager by more than any excess earnings the fund manager may earn.
Need for Rebalancing
Long term investors should consider periodic rebalancing. Rebalancing means resetting your investment mix to your desired distribution. By periodically rebalancing one has the opportunity take advantage of market shifts. For example if you invest 5% of your investment in Large Cap growth and 3% in gold and then large cap growth increase relative to gold so that it is now 6% of your portfolio and gold is at 2%, you would sell large cap growth to 5% and buy gold back to 3%. Then at the next rebalance if gold had risen relative to large cap growth so that both are now 4% of your portfolio, you would buy large cap growth and sell gold. You are engaging in the practice of buying low and selling high. A downside of rebalancing is that the item you are selling down may continue to rise while the item you are building up could continue to fall.
Being the Market – But tailoring your investment to meet your needs
If the overall financial market consisted of 60% bonds and 40% equity, it would be easy to split your funds between a bond ETF and an equity ETF on a 60/40 split. However, there are many bond dimensions (e.g., High Quality/Low Quality, Short duration/Long Duration) and many equity dimensions (e.g., Large Cap/Small Cap, Growth or Value). In addition both equities and bonds come in geographic flavors such as Domestic US, International (Developed) countries, and Emerging Markets. One could simply split ones investments according to these splits and “Be” the market. But there is much more involved with personal investing. Each person has a different investment objectives, different risk tolerances, different time horizons, different liquidity needs, not to mention we all come in different ages.
There is a global investment paradigm that essentially says the percent of your investment that should be in equity is 100 minus your age. Thus, if you are 40 years old you may want to havee about 60% in equity and 40% in bonds. But, as life expectancies have risen coupled with people working longer and retiring later, this number may have shifted a bit more to equity throughout one’s lifecycle. A drawback to this paradigm is that fails to address those who wish to invest in “alternatives” such as gold and real estate. In addition, this paradigm does not address the need to adjust one’s mix based on their risk tolerance, investment objective, investing timeline, or other personal attributes that could impact the ultimate investment mix. Furthermore, there are times when the market may be trading at higher or lower valuations than historical averages, while bonds may be yielding higher or lower rates than historical averages. Each of these items could impact your desired investment mix. Finally, we all hope that we continue to get older. Because of this, when we rebalance, we may want to dynamically adjust our investment mix. How does one keep up with changes in our target mix considering we need to factor in changes in our age, risk tolerance, time horizons, investment objectives, and market characteristics? The Answer is the CaMDAR® Model.
Client and Market Dynamic Age-based Rebalancing (CaMDAR®) Model
Client and Market Dynamic Age-based Rebalancing (CaMDAR®) Model is an investment model that invests solely in ETFs. The investment mix is an Age-based rebalancing model that adjusts the clients actual age to an investment age based on both Client and Market characteristics. It is Dynamic in the sense that in each rebalancing period, Market Conditions and Client characteristics can change the investment age. For example, if a client previously had a high risk tolerance but has come upon an additional windfall and does not need to be as aggressive in the market to meet his financial needs and therefore indicates a change to a Low Moderate Risk level, this will have an impact of increasing the Investor age increasing exposure to fixed income and away from equities. Likewise if the market takes a major setback reducing valuations and making equities more favorable, this will have an impact of lowering the client’s investment age causing a higher allocation to equities.
CaMDAR® uses ETFs covering small Cap, Mid CAP, and multiple Large CAP ETFs. It also has ETFs focused on High Yield Bonds, Short Term Bonds, International Bonds, along with both International and Emerging Markets equities and Domestic and International real estate and Gold. Currently, there are 23 possible holdings although not all will be used for each client based on their investment age.
CaMDAR® is designed to be used within a Wrap Account. A wrap account charges the client a fee based on a percent of funds under management but charges no transaction fees. This allows for rebalancing at no incremental cost to the client.
How Often to Rebalance
The frequency of rebalancing is a variable in the CaMDAR® model. Rebalancing can create a tax gain or a loss as positions are sold. Rebalancing too frequently could have diminishing returns and if too frequently may result poorer performance. Although most ETFs are traded with relatively large volumes, there is still a difference between the Bid and Ask price. Sometimes this may be a cent or a fraction of a cent per share but sometimes it can be greater depending on the specific ETF. Tax deferred accounts may have a shorter frequency for rebalancing than non-deferred accounts because there is no immediate tax effect. Usually a period of 1 year, a half a year or a quarter is sufficient for rebalancing.
In addition to the frequency of rebalancing, one should ask what the threshold should be for rebalancing a particular holding when rebalancing is taking place. If for example, you want Large Cap Growth ETF to be 5% of your holdings and at rebalancing time it is 5.05%, is there sufficient value in trading to bring this to 5.00%. Also, depending on the price of an ETF, it may not be possible to get an exact allocation. Although CaMDAR® is done in a wrap account putting the marginal cost of trades at the feet of the financial professional, there is a cost associated with trading. The more the cost for the professional increases, the more likely he or she may need to increase fees under management. Therefore with the CaMDAR® model, a relative rebalancing percent can be captured up front along with the determined period for rebalancing when the financial professional and the client agree on the percentage charge for fees under management. A possible relative rebalancing threshold may be 20%. This means if an ETF was to be 10% of your holdings, it will be rebalanced if it reaches 12% or drops below 8%. Note, because funds are needed to buy additional shares if rebalancing requires a buy and cash is generated when selling shares when rebalancing requires a sale, there will be instances where holdings will need to be rebalanced while within the threshold in order to rebalance a holding that is outside the threshold.
If you have an investment account that has at least $50,000 in assets, you should investigate if the CaMDAR® model is right for you. Regardless if it is a tax qualified account such as an IRA or a 401K you wish to rollover, or if it is an individual or joint account, the CaMDAR® model may be the answer to your investment needs.
For more information in the CaMDAR® Model, please contact Douglas Rounds at 605-224-9223 ext 1165.