Introduction to the Guided Portfolio Process

Investment Strategy

Guided Portfolios are constructed and managed according to a carefully designed process that marries top-down strategy with bottom-up stock selection.  Top-down analysis is used to determine the number of stocks to be included in the portfolio from each sector of the market while bottom-up analysis is used to select which stocks will be held in each sector of the market.  The portfolio is reviewed on a daily basis with major re-evaluations taking place at the end of each quarter.
 

Top-down Analysis

Every quarter, our top-down strategy process forecasts the key variables on which our macroeconomic view is based: the expected direction of interest rate moves, the level of economic growth, the level and growth of corporate earnings and, the prevailing valuations of equity markets.  This process forms the foundation for the recommended sector over-weights and under-weights within equity portfolios.

We then assess the underlying fundamentals for each sector.  Our process considers relevant factors such as valuation and the appropriate industry dynamics.  These factors are measured both on their own, and relative to other sectors, taking into consideration our economic forecast.

We utilize the 10 sectors outlined in the Global Industrial Classification Standards and followed by Standard & Poor's.

  • Financials
  • Telecommunication Services
  • Utilities
  • Consumer Discretionary
  • Consumer Staples
  • Health Care
  • Industrials
  • Technology
  • Materials
  • Energy

Portfolios generally consist of 20 stock positions plus one cash position.  For every 5% that a sector comprises of the Standard and Poor's 500 index, that sector is entitled to 1 stock position within the portfolio.  Consider the following examples:

  • The Health Care sector is approximately 14% the Standard and Poors 500.  If the sector were to be represented at market weight, 3 stocks out of 20 would be devoted to Health Care.  We limit the degree of sector bets to 50% above or below market-weight, subject to rounding at our discretion.  In the Health Care example, at the maximum over-weight there could be as many as 5 stocks and at the maximum under-weight there might be as few as 1.
  • For sectors where the market-weight is less than 5%, market-weight is considered to be 1 stock and the allowable range would be 0 2 stocks.


Bottom-up Analysis

Our bottom-up stock selection procedure is multi-disciplinary and uses only the Standard & Poors 500 and the stocks in the Toronto Stock Exchange/Standard & Poors Composite.  Together, this represents a universe of approximately 750 stocks.  Each stock is scored by the following three disciplines:

  1. Fundamental Score: using a variety of fundamental analytical resources available to RBC Global Investment Management, each stock is assigned a fundamental score.  This takes into consideration factors such as the relative attractiveness of different companies business models within an industry, the strength and focus of their products, the depth and strength of management, the health of a companys balance sheet, its ability to generate free cash flow and the relative attractiveness of various companies valuations.

  2. Technical Score: each stock receives a technical score that attempts to capture the longer-term strength of both its absolute trend and relative trend against the stock market.  This score also incorporates a momentum indicator of both absolute and relative strength designed to be a leading indicator of future trend changes.

  3. Quantitative Score: a proprietary objective screen in which a model of past financial performance coupled with other inputs, like estimate revisions, is used to form a cumulative rank of individual growth, momentum, value and predictability scores:  

  • Value: companies whose share prices are relatively low compared to different measures of their fundamental value;
  • Growth: companies that have shown attractive earnings and dividend growth and returns on equity through time;
  • Momentum: companies that are currently delivering strong earnings and revenue improvements;
  • Predictability: companies that have exhibited a high degree of earnings stability through time.

Stocks that score well across the three disciplines form the pool of candidates for final selection.


Sell Discipline

Importantly, our sell discipline is very well defined:
  • Stocks are monitored on an ongoing basis from a fundamental perspective.  A change in the minimum fundamental score or a change in the perceived risk/return characteristics results in an immediate sale;
  • At the end of each month, the technical score is revisited focusing on minimum levels of absolute or relative strength as determined by our proprietary model.  Deterioration in this score causes removal;
  • Each quarter, the number of stocks positioned in each sector is revisited.  A change in industry outlook that triggers a change in the number of stocks allocated to that sector would cause a sale; Each quarter, the three discipline scores are determined for each stock and those exhibiting deterioration in their scores are removed.

In the event of a sell signal, one of the following actions will be taken:

  1. Sell the security at the time of removal and replace it with another company in the same sector.  The replacement trade does not have to take place at the exact time of the removal of the previous stock;

  2. Hold the stock until the next quarterly updated or a more timely point for sale;

  3. Sell the stock and hold the proceeds in cash until the next quarterly update.

For more information on the Guided Portfolio Process, please feel free to call our office at 960-4929 or 1-800-668-3066.