Risk and Reward: A 5 Step Framework for Capital Deployment in a Fully Valued Market

By Sam Katzman, Executive Managing Director, Wealth Advisor and Paul Tramontano, Executive Managing Director, Wealth Advisor

Perhaps lost in the noise of what the market is doing on a day-to-day basis is the difficulty of putting new money to work in a world where most asset classes are fully valued – a remnant of a flood of liquidity thrown at the economy via government stimulus packages following the COVID pandemic.  

While Americans seem as engaged as ever in stocks and the run of the Magnificent 7 (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla, and Meta), fund flows show that since the Global Financial Crisis (GFC), retail money has left the domestic equity market, with the vast majority invested in bond funds and ETFs instead. These flows into fixed income occurred even though yields remained near historic lows for most of that time. The mania into fixed income peaked in December of 2020 when roughly $18.4 trillion of bonds globally had negative yields to maturity.

Asset allocation became extremely difficult as the yields on fixed income approached zero and many investors felt forced to undertake more risk in their portfolios to generate the returns they needed to achieve their financial goals.

Now, after an aggressive hiking cycle by the Federal Reserve, interest rates are normalizing, and the fixed income market has again become attractive with interest rates currently exceeding inflation. That has not made putting money to work much easier, however. Many investors often find themselves out of sync with their desired allocation, either through inconsistent oversight, a sudden infusion of wealth, or fear of making purchases at the top of a cycle. We are often introduced to clients after a monetization of a business, or other event, and are tasked with deploying the capital in a thoughtful way.

A 5 Step Capital Deployment Framework

The following process has worked for our clients and is a solid framework from which to begin:

 1. Establish a Long-Term Asset Allocation

Start by developing an asset allocation that works for you for the long run. This allocation should consider your risk tolerance, liquidity needs, return goals, and other quantitative and qualitative considerations. Depending on the size of the portfolio, we often reserve a significant amount for alternative investments aside from the public equity and fixed income portions of the allocation.

2. Develop a Timeline for Investment for Each Asset Class

Once the allocation is determined, develop a plan to get money invested in each asset class. For fixed income, we generally deploy the capital immediately with the duration of the portfolio set given our rate outlook and where we are in the business and monetary cycle. A laddered municipal or taxable fixed income portfolio will be averaging into the longer end of the curve by its nature and so there is no need to wait to invest.

3. Dollar Cost Average Into Public Equities

For public equity investments, determine a timeline from which to dollar-cost average into the various managers and/or passive vehicles selected. Allow enough time to ensure that you will receive the benefit of some drawdowns and perhaps provide the latitude to slightly accelerate the investment plan should a significant drawdown occur (on average, stocks suffer a 14% drawdown in any given year*). We often allow up to three years before we will be fully invested in our equity allocation.

4. Passive vehicles should be chosen carefully

Be thoughtful about which indices you choose for the passive portion of the allocation. The S&P 500 has become much more of a growth-oriented investment as the large cap technology stocks have grown as a percentage of the total. If combining the index with active management, keep their styles in mind to ensure you do not over-concentrate in growth equities. Consider an equal-weighted vehicle as a complement to a cap-weighted index to ensure better diversification and exposure to different types of equities.

5. Alternative investments generally take years to get invested

For alternative investments, realize that it will take a few years for money to be put to work as commitments are usually made up front, but capital is drawn over an investment period that generally varies from three to five years. For us, this category includes real estate, hedge funds, private equity, and other niche types of strategies that avail themselves of the inefficiencies that often exist in illiquid markets.

Overcome investment fears by making a plan and sticking to it

There is no easy time to put money to work from a psychological perspective. If the market is down and the economy is faltering, waiting feels like a smart move.  However, markets are forward looking and most often turn before economists and the data become positive. Conversely, when the economy and markets are strong, it is hard to overcome the fear of buying at the top. Both circumstances can be remedied by having a plan and sticking to it. Working with an advisor that offers a dispassionate voice can be very helpful in taking the emotion out of the process.

Think long-term (5-10 years at a time)

Finally, avoid being too shortsighted when judging the success of an investment. Empirical evidence shows that the overall volatility of returns compresses, and the asymmetry of returns moves in your favor as the investment time horizon expands, so force yourself to think longer term. Over five- and ten-year time periods, it is unlikely that you will lose money in a diversified asset allocation, and far more likely to compound returns in excess of inflation.  Investors are often the biggest impediment to achieving their own financial goals, following the above advice can help overcome this obstacle.

Contact us to learn more strategies for effectively deploying capital in a fully valued market.

*Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management.