The Adaptive Wealth Strategy U.S. Factor Index employs a reversion to the mean process to dictate which investment theme to own at any given time. The underlying themes have researched-backed, academically sound investment philosophies and significant historical advantages compared to traditional indexing.

 

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Over time, our concept uses three factors: minimum volatility, value, and momentum.  The end goals are low tracking-error, minimal internal expenses, downside protection, and alpha generation.

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MiNimum Volatility

Minimum volatility, was one of the earliest innovations in the investment profession. The starting framework, “Modern Portfolio Theory,” was developed by Harry Markowitz in 1952. While 1952 is far from modern, the idea that risk and return are inherently linked is as applicable today as it was over 60 years ago.  The minimum volatility theme essentially recreates the Modern Portfolio Theory by maximizing the return for a similar amount of risk, and better downside protection than the overall market.  This factor helps to provide both stability and diversification inside our adaptive factor model.

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Value

Value, derives significance from the research of Eugene Fama and Kenneth French in their “Three Factor Model.”  This model suggested that value stocks tend to outperform growth stocks over time.  While there are multiple ways of defining the value factor, a balanced approach of earnings, book value, and dividends provides an intuitive and common sense way of screening for value.  This factor also has a tendency to revert to the mean, which means there are times when value will both underperform and outperform.  We believe that over time, investors are rewarded for buying equities at discount prices.

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Momentum

Momentum, has its roots in the behavioral side of investing.  In 1997, Mark Carhart expanded on the research done by Fama and French, and added a fourth factor to complement their research: momentum.  The easiest explanation is: stocks that have outperformed recently will tend to outperform in the future.  We think of this as the "herd mentality".  Investor behavior tends to lead to buying prior winners and avoiding prior losers.  This factor, much like value, tends to mean-revert and will both outperform and underperform during different cycles.

Read more about our factor methodology:

The best interest of the client is the only interest that matters. 
— Larry W. Carroll, CFP® 1980

We have always strived for customization, consistency, and simplicity.  Over the years, we have delved into a multitude of products and strategies to find what is best for our clients.  Through those products, we’ve experienced capital gains distributions from mutual funds, large tracking-error from active management, and zero-alpha from purely passive vehicles.  Despite those hurdles, and regardless of vehicle, our risk management philosophy and mean-reversion strategy of targeting longer trends in the market prevailed. 

With the advent of factor-based ETFs, we recognized we could better capture our factor strategy by combining minimum volatility, value, and momentum.  What were once three separate positions became one by utilizing an ETF vehicle, thereby virtually eliminating capital gain issues when we needed to sell one factor for another.  Enter the Adaptive Wealth Strategies U.S. Factor Index.

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The Adaptive Wealth Strategies U.S. Factor Index was built with the end client in mind, and replicated a strategy we were already using in our investment accounts. 

Looking at minimum volatility, value, and momentum, we simply looked at how they performed compared to one another. 

The end methodology will own either: two factors at one time, equally weighted 50%/50% or all three factors with a weighting of 40%/40%/20%

Our methodology will look to eliminate or underweight the best performing factor over a specified trailing time period. 

Our goal is to own the factors that are overly stretched on the downside and avoid the ones that are overly stretched on the upside.  This provides the opportunity for the under-performing factors to appreciate and hopefully avoid the factor that is about to fall. 

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This strategy serves as the core U.S. Large Cap Equity allocation in client portfolios.  This would typically represent anywhere from 70-100% of the U.S. Equity allocation within an account.

Larger Accounts: 

For larger accounts, we would typically use this as the heart of the U.S. Equity allocation, and satellite it with smaller positions that are more thematic and have higher tracking error to the benchmark.

Smaller Accounts:

For smaller accounts, this is a great strategy for the full allocation as it exhibits better downside protection than a standard passive index, while also generating a positive alpha.  

 

Whether it is a small-cap strategy, sector investment, or thematic allocation, we are more confident in making tactical decisions knowing that we have a large core allocation to our Adaptive US Factor Strategy. 

Read more about applications of this index within a portfolio: 

Far too often, investors seek near-term trends or quarterly performance, forsaking a well designed, long-term strategy.  We believe risk and return are best judged over a long horizon. We also believe that downside protection is critical, as this can potentially limit poor behavioral decisions that may trigger exiting markets at an inopportune time.

 

Annualized Returns

Data shows performance from 9/1/2001 - 7/31/2019 (In Percent)

Calendar Year Returns

Data shows performance 9/1/2001 - 7/31/2019 (In Percent)

Disclosures

An investor cannot directly invest in an index.  Returns shown are calculated by a third party vendor, Solactive AG.  The date range for historical, back-tested information for the Adaptive Wealth Strategies U.S. Factor Index (the ‘index’), is September 1, 2001 through August 7, 2018.  Past performance – both actual and back-tested – is not an indication or guarantee of future performance.  All performance data is shown without any associated fees or trading costs.  No information given is intended to be investment advice or a recommendation for any kind of investment decision or asset allocation and should not be relied upon advice.  Charts and graphs are provided for illustrative purposes only.  Index returns shown may not represent the results of the actual trading of investable assets.  Back-tested performance is not actual performance, but hypothetical based on the same methodology that was in effect when the index was officially launched on August 8, 2018.  Back-tested information may reflect the application of the index methodology with the benefit of hindsight.  Charts above may be partly comprised of historical performance illustration based on a back-test.  S&P 500 TR information was sourced from Zephyr.  Comparison information is for informational purposes only, constituent and weighting metrics can and will be different from the comparison index.  The following companies are not affiliated, Carroll Financial, Solactive AG, S&P 500, Informa/Zephyr.  Adaptive Wealth Strategies® is an investment division of Carroll Financial Associates Inc. 

Learn more about our index by downloading our whitepaper and index guidelines: