Over the last couple of months, we have been preparing to expand our product offering by launching two new sets of strategies, called the Market series and the Quant series. They are offered as alternatives to our traditional strategies, now referred to as the Prime series, for a chance to help our current and future clients achieve their financial goals. While the Market series and the Quant series are different under many aspects, they share one important feature: under both strategies, a portion of the client’s portfolio is managed according to a rules-based, quantitative model developed in house at Pinnacle. Diversification has always been a core tenet of Pinnacle’s investment process and the way we manage risk. However, with this move, Pinnacle has now further expanded the diversification it offers to clients to a new dimension of risk: decision risk. While the Pinnacle traditional (now Prime) strategies rely primarily on the time-proven judgment, experience, and intuition of the members of the Investment Team, the new strategies are based on a rules- based decision-making process that is more objective and unemotional. In Pinnacle jargon, we say the Prime strategies are subject to manager risk, while the new strategies are subject to model risk. Modern Portfolio Theory tells us that by combining different sources of uncorrelated risks, we can move our portfolio farther out in the efficient frontier and achieve a better expected return-to-risk ratio.
The Dynamic Quant Series is constructed by adding a quant allocation to the Pinnacle Moderate “Prime” Strategy. The Quant allocation is a proprietary quantitative model for sector rotation based on relative value and momentum. The model ranks the ten sectors of the MSCI US Index* based on a range of relative valuation and momentum metrics, and systematically overweights (underweights) the sectors with the most (least) attractive overall scores. Since valuation plays an important role in this model, it is not surprising that the quant allocation of the portfolio moved to an overweight position in energy after the sector experienced a 21% decline in price in the second half of 2014. Interestingly enough, this move happened at the same time as the Pinnacle Investment Team has been reducing the exposure to the energy sector that we carry in our Prime strategies, mostly due to concerns that excess supply of oil and a strong USD may act as headwinds for the sector in the foreseeable future. Notably, investors in the Dynamic Quant Series will own energy positions in both the core or Prime portion of the portfolio as well as the Quant allocation of the portfolio. Only time will tell whether the Investment Team (the man) or the model (the machine) will get the call on the energy sector right. However, what we do know is that each of them is doing exactly what it is supposed to do: make investment decisions based on methodologies that are different and at times uncorrelated, but equally valid and reflective of Pinnacle’s strive for excellence.
*The MSCI US Index is a well-known market-capitalization-weighted index reflecting a full breadth of investment opportunities within the US equity markets. The MSCI US Investable Market 2500 Index contains 2,500 stocks, and represents approximately 98% of the full capitalization of the US equity market.