We believe in maintaining a fully invested portfolio. Using this approach, we take advantage of the long-term growth trend of the American and world economies. In addition, we eliminate market-timing errors and reduce transactions and tax costs.
Investment management always involves a trade-off between return and risk. To generate higher expected rates-of-return, one necessarily assumes greater investment risk in the form of greater return variability. One key to successful investment is to avoid unnecessary investment risk.
To this end, we establish and maintain a well-defined and wide-ranging asset allocation plan for each client portfolio. Academic studies have shown that asset allocation is the most important determinant of portfolio performance. In addition, a good asset allocation plan can reduce risk by diversifying investments across many market sectors and in many world economies. Adherence to a well-defined asset allocation plan can also impose management discipline by limiting the tendency to over-invest in markets that are doing well at the moment and are therefore expensive and to neglect markets that are currently under-performing and are therefore relatively cheap.
We use mutual funds as our preferred investment vehicle for a number of reasons. Mutual funds are an inexpensive way to provide security level diversification. A properly diversified stock portfolio requires anywhere from 40 to several hundred stocks. This level of diversification can be achieved by using a handful of mutual funds. Mutual funds receive better trade execution and have much lower trading costs than smaller investors. Funds provide a way to access specialized market knowledge of many fund managers at once.
Although we use these quantitative techniques to evaluate mutual funds and to construct investment portfolios, we realize that computers are no substitute for market experience and judgment and we carefully review portfolio transactions to make sure they conform to the clients needs.
The first step in the process is to assess the clients investment needs. Evaluating the clients financial information as well as personal preferences, we arrive at an appropriate risk tolerance level for the client.
Once the proper risk level for a client is established, we design a detailed asset allocation. Clients who can and want to tolerate higher risk levels get higher allocations of risky assets that have higher expected returns. Clients with lower risk tolerance are allocated more lower risk investments. The allocation is then adjusted for the special needs of the client. Personal preferences, other investment assets not managed by Paragon, etc. can affect the final allocation.
Whereas a typical investment manager might allocate investments into broad categories such as stocks, bonds and international investments, we perform an allocation that is much more detailed. As an example, we divide domestic U.S. stocks into six sectors and make detailed allocations into each sector. Since these sectors behave very differently, especially in recent years, we believe that such an allocation provides much better diversification and risk reduction.
The next step in the investment process is to evaluate mutual fund performance. Our mutual fund database contains information on over 20,000 funds. Using simple filtering techniques, we narrow the universe to about 400 funds. We perform "style analysis" on these funds. Style analysis is a statistical technique used, in part, to determine the underlying asset allocation of a mutual fund. In order to achieve the detailed asset allocations we have designed for our clients, it is critical to have the asset allocations of the mutual funds we are using.
In addition to asset allocation information, style analysis also provides us with a measure of the management skills of the mutual fund portfolio manager. Traditional mutual fund analysis usually compares a funds performance to some market index; however, most funds have asset allocations that do not resemble any particular market index. Without using style analysis, it is very difficult to evaluate mutual fund performance because it is usually not clear to which performance benchmark to compare the fund to.
Next, we use the style analysis data and the client asset allocation to construct a mutual fund portfolio. We use a proprietary system to choose a combination of mutual funds that achieves the target asset allocation for each client using mutual funds that we consider well-managed.
After we make the initial investments, we monitor the portfolio to make sure it is tracking the target asset allocation and to make sure the mutual funds continue to perform well. Balancing portfolio efficiency, transaction costs and tax considerations, we make adjustments to the portfolio as necessary.
Gene Chow is the founder and chief portfolio manager for Paragon Asset Management, directing investment policy, fund analysis and portfolio design. Prior to founding Paragon in 1989, he was a portfolio manager for eleven years at Robert C. Brown & Co., Inc., an institutional money management firm based in San Francisco. His last position at Brown & Co. was President of the Investment Management Division where he was directly responsible for the management of more than $1 billion in institutional fixed income assets. In addition, he was Executive Vice President and Director of Brown & Co., and a Vice President and Director of the firms broker-dealer and insurance subsidiaries.
In other positions at Brown & Co., Gene directed the research and development of quantitative fixed income management strategies for institutional clients including public and private pension funds, corporations and foundations. In addition, he designed and implemented asset/liability matching strategies for life and casualty insurance company clients. He also helped establish and manage the Robert C. Brown Money Market Fund.
Gene earned a B.S. in electrical engineering and computer science and an M.B.A. in finance from the University of California, Berkeley. He is a Chartered Financial Analyst and a member of the CFA Society of San Francisco.
Linda Lee is Executive Vice President and the Chief Financial Officer for Paragon. Her responsibilities include internal operations and client services. From 1988 until 1991, she was Senior Vice President and Chief Financial Officer for Richard C. Blum & Associates, Inc., a registered investment advisor and investment banking firm in San Francisco.
Previously, Linda was Vice President and Chief Financial Officer of S.G. Warburg & Co., Inc. (pre-merger, Rowe & Pitman, Inc.), a New York Stock Exchange broker/dealer with international institutional clientele and research product. As registered financial principal for the firm, she was responsible for all corporate financial and operational aspects of the company.
Linda earned a B.S. in accounting from the University of California, Los Angeles and an M.B.A. in finance from the University of California, Berkeley. She holds board memberships with a variety of non-profit organizations, including TMC Development Corp - a conduit for SBA loans into the community and Working Solutions - a microloan assistance program.