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Keeping an Eye on the Downside

Windhaven is a managed portfolio solution with a global approach to diversification and a focus on downside risk management. The firm analyzes more than 40 asset classes in an attempt to capture growth when markets are rising and reduce exposure when they decline. Windhaven offers three broadly diversified strategies, which invest primarily in low-cost index exchange-traded funds (ETFs).

To find out more, Onward sat down recently with Windhaven’s Chief Investment Strategist Christian Menegatti to discuss the company’s investment philosophy and his take on the markets.

Q: Tell us about Windhaven. What makes it different?

Christian Menegatti: Three key concepts describe our style. You could call them the three Ds: downside protection—as in trying to minimize declines—dynamic asset allocation and diversification.

So many funds and managed accounts are focused singularly on alpha, or generating excess return relative to the investment’s benchmark. At Windhaven, we dynamically adjust asset allocations, striving to capture growth in rising markets while attempting to reduce exposure in declining ones. We also include a cash allocation that may take a bigger weight in the strategy when we perceive increased risk.

We’ll readily leave some upside on the table in favor of mitigating risk and protecting principal. This approach resonates very strongly with me, and I believe it resonates with our investors.

Q: Why is minimizing the downside so critical?

CM: It might seem like ancient history, but look back to the recession in 2008 and 2009, when domestic equities were down more than 50% on the year. If a portfolio declines 50%, it takes a 100% gain to get back to even.

By focusing on minimizing the downside, Windhaven strategies’ maximum drawdown during the 2008–2009 period—in other words, the size of the drop from the strategies’ high to their low—ranged from 10–33%. That was less than the maximum drawdown of the S&P 500® Index during the same period. If you’re only down 10%, it takes far less to get back to square one. That saves investors years and money.

Q: And the other two Ds?

CM: Next is dynamic asset allocation. When I say our strategies are dynamic, that means we are always trying to seize opportunities for growth while navigating uncertain markets. We’re looking to reallocate investments to the asset classes we believe are positioned to outperform in a given environment. Our tactical positioning is driven by a proprietary quantitative model but we also position ourselves for thematic longer-term views. We look at factors relating to the economy, the fundamental qualities of different asset classes and the behavior of investors. We merge that with some broad macro themes, such as the rise of the middle class in emerging markets and its impact on consumption.

The other component, the third D, is diversification. We think it’s really important to have exposure to asset classes that tend not to move in tandem. We consider exposure to domestic equities, international equities, real estate and hard assets like commodities and gold, and domestic and international fixed income securities. And we attempt to allocate so that individual parts of the strategy are not likely to rise or fall in lockstep with the others.

Q: Why does Windhaven prefer ETFs?

CM: We like ETFs because they work for us from a cost standpoint and they provide exposure to where we want to be, globally. We’re not an ETF shop. Rather, we view ETFs as a means to an end, which is global diversification in a cost-efficient way.

Q: How often does Windhaven reallocate its strategies?

CM: We have a normal reallocation frequency of three times a year. But that’s not set in stone. That schedule gives us discipline, but we may move more quickly to react to market events if necessary. That said, we’re not market timers. Rather, we aim to make sure investors are prepared for a variety of market scenarios and risks.

Q: What do you see going forward for financial markets?

CM: Volatility is a definite theme. Diverging policies from global central banks could stoke more market swings in the coming months. Investors have been grappling for a while now with the implications of the Federal Reserve’s desire to bring monetary policy back to normal, as the European Central Bank and the Bank of Japan both introduce stimulus programs meant to spur economic growth. These divergences constitute largely uncharted territory. As global disinflation is likely to persist and keep markets nervous, periods of heightened volatility are likely.

Q: What does that mean for investors? How do you position your investments to reflect your outlook?

CM: A volatile environment is generally one where you want to be positioned for a down market. That means being invested in more than just U.S. or global large-cap stocks. Look at U.S. fixed income—some managers are beginning to abandon this asset class. But U.S. fixed income has historically been considered a safe haven during times of heightened risk aversion, global deflation and financial stress. And look at the geopolitical risks out there—Greece, Venezuela, the Ukraine, the Middle East, the strong U.S. dollar … I could go on.

We’re not abandoning asset classes like U.S. fixed income, or commodities like gold. We will likely always have some exposure to those, even when the Fed is intent on raising rates. These asset classes can provide protection in case of a shock, and we believe we need to be ready. That might mean, at times, leaving some upside on the table, but that’s consistent with our investment philosophy.

About Windhaven

You can get started with an initial investment of $100,000 or more for a brokerage or IRA account (or $25,000 for eligible ERISA accounts).

Windhaven offers three broadly diversified strategies consisting primarily of ETFs that provide exposure to a combination of U.S. and international stocks, fixed income securities, real estate, hard assets (e.g. commodities and gold) and currencies. Currently, Windhaven analyzes more than 40 global asset classes. Broad diversification, coupled with a focus on downside risk management, may help reduce losses during market upheavals while striving to take advantage of long-term growth opportunities.

Does Smaller Mean Better?
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Important Disclosures

Past performance is no guarantee of future results; the value of investments and the income derived from them can go down as well as up. Future returns and the achievement of stated goals are not guaranteed, and a loss of principal may occur.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets. Investments in managed accounts should be considered in view of a larger, more diversified investment portfolio.

International investments may involve additional risks, which could include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Maximum drawdown is a measure of risk which captures the worst cumulative peak-to-trough decline from any month-end data point to any other month-end data point. It will show in percentage terms how much money an investment would have lost until it returns to the breakeven point. For example, if you began with a $100,000 investment and you lost $30,000, before that investment returns to its breakeven level, your maximum drawdown would be measured as 30%.

Windhaven diversified strategies are available through Schwab’s Managed Account Connection® program. Please read Schwab's disclosure brochure for important information and disclosures relating to Schwab Managed Account Connection and Schwab Managed Account Services™.

Portfolio management is provided by Windhaven Investment Management, Inc. ("Windhaven"), a registered investment advisor. Windhaven and Charles Schwab & Co., Inc. are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation.

©2015 Windhaven Investment Management, Inc. All rights reserved.

(0915-3478)

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