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WEIGHTED INVESTMENT METHODS AND
TECHNICAL FIELD 5
This invention relates to methods and products for investing assets, and, more particularly, to methods and investment products based on a weighted allocation of investment resources. 10
The primary goal of an investment vehicle is to provide exceptional returns for its investors. One component of an 15 investment vehicle's returns is the returns of the underlying assets that comprise the holdings of the investment vehicle, such as stocks held in a mutual fund. To that aim, financial services firms allocate significant effort and capital to help portfolio managers and analysts identify those assets (or 20 derivatives thereof) that are likely to provide desirable results for the fund, and that will generally outperform other assets and the overall market.
In general, investment portfolio management techniques can be classified as either active management or passive man- 25 agement. Active management, conventionally, describes methods in which the assets (or other underlying investment vehicles) are selected as components of a portfolio based on one or more economic and financial statistics, analyses performed by business analysts, technical trends or some com- 30 bination of these or other elements. Furthermore, decisions of whether to buy, sell or hold a particular asset or alter a fund's weighting in an asset, industry or geographic market segment are typically performed by individuals (e.g., portfolio and/or fund managers in the case of mutual funds). Such funds are 35 often prone to large variations in performance and the operating costs attributed to many actively managed funds can be significant, and therefore erode returns.
In contrast, passive management (also known as indexbased management), relies on pre-defined indices (e.g., the 40 STANDARD & POOR'S 500, the WILSHIRE 5000, etc.), to determine the assets held within a portfolio and the weighting attributed to each asset such that the portfolio's holdings closely approximate those that make up the particular index on which it is based. Some of the advantages of passive 45 management techniques include lower trading costs, lower management costs, and very low fluctuations in performance relative to the underlying index on which the portfolio is based.
Unlike active management techniques, the weightings of 50 assets in a passively managed portfolio are typically based on the relative market capitalization of the assets that comprise the index or, in some cases, the assets are weighted equally. Advantages of using market capitalization weighting as the basis for a passive portfolio include that the index (and there- 55 fore a portfolio built on it) remains continually "in balance" as market prices for the included assets change. Market capitalization weighting is also supported by modern portfolio theory, which implies that given certain assumptions, market capitalization weighting generates portfolios that maximize 60 expected risk-adjusted return and is therefore optimal. However, one drawback of capitalization-weighted portfolios is that they can be influenced by valuation errors. For example, investors are motivated to value assets to reflect attributes such as risk and growth, but at any given point in time assets 65 may be undervalued, overvalued, or correctly valued. While investors will attempt to value assets to reflect asset attributes,
assets with low valuation may tend to reflect undervaluation errors and assets with high valuation may tend to reflect overvaluation errors.
While attributing a disproportionate amount of assets to lower market capitalization assets (either individually or in groups) may provide certain benefits, it does not consider other possible techniques for evaluating the underlying company (in the case of an equity) that may be indicative of an under priced asset. Nor does such an approach provide any methodology for determining, for example, the optimal groupings (and resultant group weightings) based on such techniques. As a result, opportunities to outperform the index and the market are missed. What is needed, therefore, is an investment vehicle (and supporting techniques for designing and managing such an investment vehicle) that takes advantage of certain operational aspects generally associated with passively managed capitalization-weighted funds, but uses additional statistical analyses and weighting techniques to position a portfolio to benefit from valuation errors as market conditions change, and thereby provide exceptional longterm risk-adjusted returns to investors.
SUMMARY OF THE INVENTION
The present invention provides techniques and investment vehicles that combine the weighting of assets within groupings of available assets by market capitalization and the allocation of capital to capitalization-weighted groupings of the assets within the investment vehicle in order to achieve superior long-term results. In doing so, the present invention benefits from the presence of undervaluation and overvaluation errors that may exist in the market. In addition, the present invention provides techniques and investment vehicles that can adjust the composition of capitalization-weighted groupings of assets as well as the allocation of capital across the groupings in response to market opportunities and benefit from such valuation errors.
The invention provides a methodology for identifying, grouping and weighting groups of assets based on relative valuation as reflected by valuation-ranked groups of assets. The invention exploits the tendency of relative valuation to signal opportunity represented by valuation errors, and allocates capital to reflect that tendency. The invention recognizes and responds to the changing opportunity set of valuation errors with regular rebalancing of strategy positions.
In general, the technique includes calculating a valuation ratio for the entire universe of assets being considered as well as valuation ratios for each grouping of assets. Based on these valuation ratios, and allocation factors and capitalization weights calculated for each grouping, a group strategy weight can be calculated (and periodically recalculated). The group strategy weight may then be used to determine the desired allocation of funds among the groupings.
Therefore, in a first aspect, the invention relates to a method for determining the composition of an investment vehicle (e.g., a mutual fund, an exchange traded fund, or a hedge fund) that includes identifying assets to be included in the investment vehicle, calculating a valuation (e.g., a book value, price, or some combination of the two, for example) for each of the assets, ranking the assets based on the valuation, grouping the assets based on the ranking, determining group strategy weights for each of the groupings and determining the composition of the investment vehicle based on the weighting factors.
In some embodiments, the method also includes calculating a target group capitalization and a group capitalization for each grouping and attributing each asset to a grouping such