Successful Portfolio Structure


At the Johnston Group, we begin each discussion with our motto – Partner, Plan, Prosper – because we want the right clients.  Not every client is a good fit…it’s not about how much money you have to invest.  It’s about providing those who are intentional, growth-oriented, and focused on outcomes with a structure to achieve success, as personally defined by them. 

This structure is a byproduct of our experience and academic research over many decades and the process is repeated on a periodic basis or as life changes dictate.  But certainly, it sometimes helps you to make life changes, and that’s the most important part. The plan is built around one’s balance sheet and cash flow – and is not blindly managed or cookie cutter by any means.  Only after many discussions do we know which asset allocation is appropriate given your need for risk, tolerance for risk, and capacity for risk.  

Importantly, these principles must be considered in the context of an overall investment strategy.  This means not evaluating one account or specific investment in isolation, but by the functional role it plays within the entire portfolio.  To elaborate, every asset owned plays a role.  Investors often build portfolios from the bottom up, “collecting” funds as opposed to thinking about how or where they should fit into an overall allocation.  In contrast, proper asset allocation balances risks and returns and uses diversified investments to avoid exposure to unnecessary risks. 

In practice, diversification is a rigorously tested application of common sense.  Markets and asset classes will often behave differently from one another – sometimes marginally, sometimes greatly – at any given time.  Owning a portfolio with at least some exposure to many or all key market components ensures the investor participates in the strongest markets while mitigating the impact of weaker areas. 

We use a systematic approach that is based upon fundamental relationships between asset classes.  Simply put, we look for the “fat pitch” and employ a patient and flexible trading approach.  We swing at the fat pitch only when it presents us with the opportunity for higher returns, lower expected correlations, or an opportunity to benefit from unusual market inefficiencies.  When rebalancing, we seek to reduce risk by allocating across major asset classes and potentially increase returns by reallocating within asset classes by investment style, geography, or firm size, where mean reversion is most likely to occur.

The last step is how do we implement it – and we are guided by three pillars that work in your best interest and serve as the core of a long-term strategic approach to investing. 

  • Broad global diversification
  • Tax efficiency
  • Low costs

We use a time-tested process backed by 50+ years of research in financial science.  Any investment manager can do well for years, but long-term evidence-based investors demand more, where proof is measured in decades.  Leaning on Nobel-prize winning research into financial markets that is grounded in both economic theory and backed by decades of empirical research, we seek to create portfolios capable of achieving certain ranges of return.  By using index funds, we embrace the idea that markets are correct more often than they are wrong, and that the existence of many diverse investors ensures prices reflect most, if not all, available information.  In all cases, we seek to provide institutional-quality solutions across all asset classes including stocks, bonds, and real estate, with a focus on outcomes, transparency, and impact on goals.

Research has shown that securities that offer higher expected returns share certain characteristics that have historically been rewarded over time, also known as risk factors. To be considered a factor, these characteristics must be sensible, persistent over time, pervasive across markets, and cost-effective to capture to increase the reliability of expected outperformance.  The four primary factors we seek to exploit are: equity premium, size premium, relative price premium, and profitability premium.

We know market timing is futile, and “time in the market” matters much more.  Because market timing is difficult, we don’t rush into and out of factors.  Instead, we prefer to implement modest tilts around our strategic allocation, and diversify the portfolio across key factors.  Factor tilting – as opposed to “into and out of” market timing – can enable higher returns while maintaining the benefits of a well-diversified portfolio.  While each of the factors is valuable on their own, it is even more effective to combine these insights into a composite so that when one factor isn’t “working,” odds are that others will. 

Selective Ownership of Active Managers

When we believe an investment manager has an effective, time-tested, and repeatable process for generating attractive results, we are comfortable allocating assets to active strategies.  For example, one of our top investment managers has embraced strategic beta strategies using quantitative tools that we would be challenged to implement on our own at a similar price point.  All of the firm’s funds earn Morningstar medals and over 85% have outperformed the benchmark over long time periods, compared with under 20% for the overall market.  In general, when searching for an active manager, we expect to see skin in the game via employee ownership or direct participation in the fund, minimal turnover, a repeatable process, creativity, and low costs.

Selective Ownership of Extraordinary Businesses

While diversified portfolios serve as the strategic core of our investment models and are anchored in low-cost index ETFs, many clients benefit from the select ownership of wonderful individual businesses. As opposed to buying a stock which might be owned for just a few months, we seek to identify and purchase long-term compounding machines that can grow their earnings for many years through any economic environment by finding underleveraged, well-managed businesses with the following characteristics.

  • Competitive advantages and strong market position, to sustain high returns on capital and growth
  • Solid balance sheets which provide for financial firepower to invest back into the business
  • Valuation reasonably in line with the overall market

For instance, an algorithm can’t possibly appreciate the inherent powerful structural advantages of a company such as Berkshire Hathaway.  Let’s just say while the market is highly efficient over time, it does break down from time to time and our familiarity with quality businesses gives us a leg up when investors get terrified and sell into panic for non-fundamental reasons.  Of course, individual stock ownership is simply complimentary to a foundation that consists of effective asset allocation using diversified funds to lower volatility and thereby improve risk-adjusted returns. 

David WebbMike Giefer