Guiscard Capital's Asset Allocation Framework Explained

Guiscard Capital uses an Asset Allocation Framework to assess risk-adjusted of an asset class, such as US equities. The Framework considers a range of financial market and economic indicators in the following areas:

  • Absolute Valuation

  • Relative Valuation

  • Fundamentals

  • Economy

  • Central Bank and Government Policy

  • Sentiment

  • Trend

The weight assigned to each variable depends on the investment horizon. For example, the longer (shorter) the horizon, the more (less) weight given to valuation.

Each variable is scored from +2 or very attractive to – 2 or very unattractive. The framework combines measures that correlate with short-term (e.g. sentiment and trend), medium-term (central bank and government policy, economy and fundamentals) and long-term (e.g. relative and absolute valuation) investment returns.

The overall framework score can, in theory, range between +14 and -14.

We use the Framework to try and take a holistic view of risk and return. Importantly, the Framework is diversified by using a variety of different indicators AND considering more than one time horizon.

Changes occur gradually. We don’t use this framework to make 100% in or out market timing calls.

Guiscard Capital uses a weight-of-evidence approach to interpreting the model. We try not to let our decisions be overly influenced by any single factor as this increases the risk of behavioural biases (such as recency/primacy effect, confirmation bias and anchoring) influencing our decisions.

We focus primarily on the level and the change in scores. For example, scores between +5 and -5 are considered neutral. Strategy allocations are invested more or less in line with their default risk profile. This is what we mean by paying attention to the level. A sudden fall or rebound in the score is a danger sign that the trend might be changing.

Changes to allocations are also an outcome of our Risk Management process. We use risk management tools such as stops. When stops are triggered, shares are sold and the level of cash increases. We use the Asset Allocation Framework (in particular the short-to-medium term indicators) to help us decide when to re-balance portfolios back to the current target asst allocation (based on the Framework's overall score).

Asset allocation shifts are implemented gradually, not as all-or-nothing bets. Most of the time the asset allocation framework offers a mixed message. Its best to wait for a strong signal (i.e. higher conviction) before making major changes.

The Framework keeps us disciplined. It’s easy to wait for a “buying opportunity” or “take some profits”. But what does this really mean? How are these events defined? What if they don’t happen? How will I know if we're wrong? The asset allocation framework helps prevent our answers to these questions from drifting over time due to the influence of hindsight bias.

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