R4A Definition of Predefined Investment Strategies
Objectives, Risk, and Composition
An investment strategy is a set of guidelines, rules, or principles designed to guide an investor's selection of an investment portfolio. The choice of an investment strategy depends on various factors, including the investor's risk tolerance, time horizon, financial goals, market outlook, and personal values. Different strategies aim to achieve different objectives, such as capital preservation, income generation, or growth, and they can vary widely in their approach to achieving these goals.
Here are six of the most frequently used investment strategies used in portfolio construction in Lumen R4A and their objectives, risk characteristics, composition, and expected return ranges.
1. Capital Preservation
o Objective: The primary goal is to maintain the original purchasing power value of the investment, focusing on minimizing the risk of loss. For example, it can be crafted for investors managing an emergency fund or a lump sum for specific future purposes.
o Target: Usually less than 4 percent for investors based in a major currency ($, Euro).
o Risk: Low. The risk targeted and associated with capital preservation strategies is typically very low. The main risk managed is inflation risk, where the purchasing power of the capital may decrease over time if the returns do not keep up with inflation.
o Composition: The approach meticulously employs extensive diversification across various asset classes and markets, recognizing diversification as a highly and most effective risk management technique often referred to as the "only free lunch in finance." In addition, risk management and diversification are further bolstered by strategic investments in sectors known for their defensive attributes, such as utilities, healthcare, and consumer staples, all displaying low volatility relative to the market, coupled with “defensive factors”[1] such as Quality and Low Volatility ETFs. (See Interactive Graph).
2. Capital Distribution/Income
o Objective: This objective focuses on generating a steady income from investments, often for retirees who need a regular income stream. Suited for conservative investors seeking a regular income stream from their investments with acceptable risk.
o Target: 4 to 6 percent based on long-term historical average for income strategies.
o Risk: Low to moderate. The risk level can vary but is generally moderate. Investments might include dividend-paying stocks, bonds, and annuities. The risks involve interest rate risk, credit risk, and market risk. There's also the risk of depleting the principal over time if the distribution rate exceeds the investment's return rate.
o Composition: Rather than relying primarily on fixed income instruments, the strategy aims to secure a diversified source of income by also investing in ETFs focused on high quality and stable dividend attributes (i.e., factors), thereby achieving the income goal while significantly enhancing risk management through effective diversification. (See Interactive Graph).
3. Capital Accumulation
o Objective: The goal here is to increase the principal amount over a medium to long time horizon, often for specific future expenses like a child's education. Designed for the investor with a longer investment horizon and explicit goals, e.g., a retirement fund.
o Target: 7 to 8 percent based on long-term average market returns.
o Risk: Moderate, in line with markets. The risk is usually moderate to high. Investments are often a mix of stocks and bonds, with the focus shifting from growth to preservation as the goal approaches. The primary risks include market volatility and the potential for short to medium-term capital loss.
o Composition: The investment strategy targets long-term market returns by implementing a balanced approach across the global capital market, i.e., across major asset classes and markets, coupled with some factor ETFs. (See Interactive Graph).
4. Capital Growth
o Objective: Capital growth strategies aim for the principal amount to increase in value significantly above average market returns. Designed for investors in pursuit of returns and capital appreciation higher-than-market by showcasing an above-average risk tolerance, and often targeting specific dollar amounts within varying time horizons.
o Target: 8 to 10 percent based on historical potential returns.
o Risk: High. The risk is generally higher, as these strategies often involve a significant allocation to stocks which are subject to higher-than-usual volatility. The investor must be comfortable with short-term fluctuations in exchange for potentially higher long-term returns.
o Composition: The investment approach is centered around the careful selection of assets and markets exhibiting elevated growth prospects, encompassing attributes and factors like earnings growth potential, and small-cap investments. The strategy allocates across a diverse range of markets, including Emerging and Frontier markets. Investors embracing this approach demonstrate a readiness to navigate the challenges posed by market fluctuations, driven by the aim of achieving returns that surpass what the broader market may provide. (See Interactive Graph).
5. Aggressive Capital Growth
o Objective: This is the most growth-oriented strategy, targeting substantial capital appreciation. It is suited and crafted for individuals with a long-term horizon, and/or an above-average risk capacity and an added inclination (and capability) towards speculation.
o Target: 10 percent and above.
o Risk: The risk associated with aggressive capital growth is high to larger than normal. This strategy often involves investing in high-growth stocks, emerging markets, or other volatile assets. It's suitable for investors with a long-term horizon with the capacity to tolerate significant market fluctuations and the possibility of substantial short-term losses.
o Composition: Building upon the growth-specific investments employed in the Capital Growth strategy, the Aggressive Capital Growth approach expands the growth-oriented investment universe to include several speculative assets such as Private Equities, Commodities, currencies, crypto, and alternatives investment in general. Investors adopting this strategy are willing to take on heightened risk and embrace a speculative bias in the pursuit of achieving faster and more substantial returns than traditional market investments. (See Interactive Graph).
6. Global Factors
o Objective: Tailored for sophisticated and well-informed investors willing to trade opportunistically, this strategy is designed to capitalize on financial and economic cycles applying Factors Investment Principles.
o Target: Returns above major benchmarks.
o Risk: High. Each investment factor has its own set of risks and potential rewards, and they often behave differently under various market conditions. Investors may choose to focus on one or more of these factors depending on their investment goals, risk tolerance, and time horizon.
o Composition: Leveraging the extensive database of R4A, the strategy is capable of ranking market-implied forward returns across major global markets, asset classes, and factors. Investors employing this approach seek to make informed decisions based on a deep understanding of the dynamic relationships among various global factors, enabling them to navigate changing market conditions and identify opportunities for enhanced relative value returns. (See Interactive Graph).
Constituents of our Strategies (by Asset Classes and Factors based on ETFs)
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[1] Factor investing represents a middle ground between passive index investing and active stock picking, offering a systematic approach to portfolio construction based on identifiable market inefficiencies.