Nerdy Investment Details
Our investment management philosophy starts with a deep understanding of market efficiency.
Because it’s very difficult to outperform the market through stock picking, sector rotation, and market timing, we do not participate in these activities.
Instead, we help our clients set up broadly diversified, risk-targeted asset allocation plans and manage them through thick and thin.
Our approach strives to maximize returns over the long haul.
"At Armbruster Capital, we believe in building wealth strategies that are not just personalized, but also firmly grounded in the latest academic research. We leverage the insights gleaned from decades of financial scholarship to guide our investment decisions and provide our clients with a robust foundation for achieving their long-term financial goals."
Mark Armbruster, CFA
Founder / CEO
Stocks
We remove stock selection from the portfolio process by using index and “factor-based” exchange-traded funds (ETFs). These investments provide a broad level of diversification at a very low cost.
Despite using indexed vehicles, we are not true indexers. While active management can be expensive and result in lower performance over time, indexing can also have its problems.
Stocks can trade at aberrantly high valuation levels (I’m looking at you, 1990s and the period just before COVID). When that happens, the market often produces lower future returns. In such an environment, the passive returns of the capital markets may be insufficient to preserve long-term purchasing power, especially if clients are taking draws to cover living expenses. This can persist for years, such as during the “lost decade” of the 2000s.
This is where our “factor-based” approach comes in within the stock allocation of the portfolio.
Factor-Based Investing
Factor investing involves using index funds with specific characteristics to tilt the portfolio toward market segments that have historically shown an ability to provide long-term returns in excess of the overall market.
Financial thinkers have discovered multiple “factors” that contribute to stock returns over the long run. This line of financial thought began with Professor Harry Markowitz’s seminal paper on Modern Portfolio Theory in the 1950s. Markowitz outlined the importance of diversification and the risk-return tradeoffs within a portfolio. His work was the basis for the development of the Capital Asset Pricing Model (CAPM), in which a stock’s systematic or market risk (also known as “Beta”) is the main factor determining the stock’s return.
Professors Eugene Fama and Ken French expanded on the CAPM with their “three-factor model.” In addition to market risk, Fama and French discovered that size (small companies tend to outperform large companies) and value (companies with low valuations tend to outperform those with high valuations) factors correlate historically with higher returns for stock portfolios. The three-factor model follows logically from Markowitz, since small companies and value stocks are inherently riskier, and therefore provide a higher expected return.
Researchers Narasimhan Jegadeesh and Sheridan Titman discovered a fourth factor, momentum (stocks that have posted positive returns over the preceding 3 to 12 months tend to continue to produce positive returns), which is also correlated with higher-than-average returns.
Several researchers from institutions such as the University of Chicago, Stanford, Yale, and other top schools have confirmed and cited this research, and these factor models are widely accepted among academic researchers.
Over time, other factors have also become widely accepted, and we try to capture their long-run expected excess returns. We use a combination of multiple factors, including value, momentum, quality, and low volatility, to try to reach for additional returns without taking on undue risk.
Historical evidence suggests factor investing has been particularly strong during periods of weak overall market returns, which is when investors need diversification and excess returns the most.
Bonds
We also use index funds for the bond portion of the portfolio. Broad-based market index funds give diversified exposure to the various components of the domestic bond market, such as government bonds, corporate bonds, and mortgage bonds. Across each of these sectors, we focus only on high-quality bonds.
We generally do not use “high yield” or “sub-prime” instruments in our core bond portfolios, as they incur risks that are highly correlated to the stock market.
We believe the main reason to own bonds is to hedge the risk of stock market declines.
Alternative Investments
Our strategy for alternative investments is unique – it includes asset classes and strategies with low correlation to the stock and bond markets. “Alternative investments” can have a range of meanings, usually including hedge funds and private equity, but we don’t use either of those.
In the hedge fund industry, you often end up with significant hidden stock market exposure and high fees. We prefer asset classes and strategies such as catastrophe bonds, private lending, managed futures, private real estate, and harvesting-style premia.
Our alternative portfolios seek out unique sources of risk and returns. We include alternative investments in clients’ portfolios to help protect against large stock market declines as well as to seek returns above those offered by the bond market.
These funds aren’t for everyone, but they have been an important diversifier for reducing risk and improving returns.
Quantitative Research
We use data from academic sources to model out asset allocation scenarios, asset class correlation, and risk/return characteristics of the investments we are considering. While we rely on research from academic sources, as a matter of practice, we use our own internal quantitative research to test new investments before implementation. We then scour the market to find the funds that best represent the return profile of the academic data sources we test.
The process includes considerations of fees, liquidity, assets under management, and the ability of the manager to execute efficiently.
Tax-Efficient Investing
Investment costs add up and can take a serious bite out of your investment returns. However, it’s often overlooked that taxes can be the biggest cost when investing. Rapid trading, market timing, and a disregard for portfolio structuring can also result in higher taxes than necessary.
We take several steps to ensure your portfolio is highly tax-efficient.
First, we use investment vehicles that are highly tax-efficient.
We like to use exchange-traded funds (ETFs) for the stock part of our portfolios. ETFs are index funds that often have low levels of trading activity, which means less potential for taxable realized capital gains. However, even ETFs with higher levels of turnover are also less likely to distribute capital gains because of a unique feature of the way they are structured.
Individual investors can buy and sell ETFs and settle their trades in cash. But there are larger institutional traders, called “authorized participants,” who actively trade in ETFs and their sales are often redeemed by the ETF fund sponsor in-kind. That means the authorized participants don’t get cash upon their sale but rather a basket of individual stocks. This allows ETF providers to swap out low-cost-basis securities without having to realize as many capital gains, which reduces the prospects for an unwelcome tax surprise at year end.
Next, we make broad use of asset location.
This means holding the right investments in the right accounts. For example, most clients don’t need more taxable income, but many want the safety of having some bonds in their portfolio. So, when there are qualified accounts, like IRAs or 401(k) plans, we like to hold bonds there. That shelters the income and defers it until retirement plan distributions are required after age 73, when clients are often retired and in lower tax brackets.
We also prefer to hold stocks in taxable brokerage accounts. That’s because stocks held for more than twelve months qualify for the generally more favorable long-term capital gains tax treatment. Clients holding stocks for the remainder of their lives may qualify for stepped-up basis, which would eliminate capital gains altogether. On the other hand, holding stocks in retirement accounts turns this more favorable tax treatment into less favorable ordinary income since all draws from retirement accounts (except Roth IRAs) are treated as ordinary income. So, we analyze each portfolio to match up the asset allocation with the asset location to reduce your lifetime tax bill.
Finally, we are opportunistic tax-loss harvesters.
That means selling investments that have declined in value and immediately repurchasing similar investments. That keeps the portfolio fully invested, but realizes a capital loss that could be valuable to reduce your tax bill now or in the future. Many investment advisors look to realize capital losses in December as year end approaches. However, at that point, it’s often too late. We look for tax loss opportunities throughout the year. For example, during the COVID downturn in 2020, stocks lost over 35% of their value in February and March, but by the end of the year, stocks were in the black. Waiting to harvest losses in December would have been a missed opportunity.
Results
At Armbruster Capital, we believe in systematically building wealth through a well-defined process deeply rooted in academic research and data-driven analysis. We avoid the pitfalls of market timing and active stock selection, focusing instead on broadly diversified, risk-targeted asset allocation plans. We leverage index and factor-based ETFs to capture market returns while mitigating risk and incorporate alternative investments to further diversify portfolios and potentially enhance returns. Additionally, we prioritize tax-efficient strategies to maximize your investment returns and minimize tax burdens.
Our investment management approach is designed to deliver consistent, long-term results, helping you achieve your financial goals with confidence. Most importantly, we understand that your financial situation and goals are unique, and we are committed to providing a personalized solution and service to address your specific needs. Let us show you how Armbruster Capital can guide you through market fluctuations while maximizing your potential for achieving financial success.