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By Scott Burns | 10-04-2012 11:30 AM

How a Go-Anywhere Manager Gets His Bearings

A 'price matters' discipline combined with a momentum process can help investors avoid catching falling knives in a down market or leaving money on the table in an up market, says RiverFront Investment Group chairman and CIO Michael Jones.

Scott Burns: The go-anywhere investing decision process.

Hi, there. I'm Scott Burns, Morningstar's director of fund research. Joining me today is Michael Jones, who is a chief investment officer and chairman of the board of the RiverFront Investment Group.

Michael, thanks for being here today.

Michael Jones: My pleasure.

Burns: So, you are participating in Morningstar's ETF Invest Conference and you were just on a panel titled “Where are the go-anywhere managers going?” But I think that kind of precludes a question. You are running a tactical asset-allocation strategy. It's one thing to know where you are going. I think it's actually more informative to think about, well, how do you decide where to go and how do you decide where to position that portfolio? So, maybe you can talk to us a little bit about your investment process.

Jones: Sure. Well, we have over the last 20 years developed a philosophy and a process around a simple concept and that's: The price you pay for something matters. So, we set our expectations of returns downside risks by looking at the price that an asset is trading at. We got 140 years of good market data. What does history tell us about what's our downside risk when we pay this price, what's our upside potential, what are our average returns? Let's do that for large-cap stocks and small-cap and commodities and bonds, and then let's put together a portfolio that optimizes the downside risk that we assume relative to the upside potential for return.

Burns: Now, I think when most people think about go-anywhere strategies, I don't think they are thinking about fundamental valuation and that does sound like what you are talking about. I think most people think that go-anywhere is chasing hot sector and things like that. How does that play into your decision, things like momentum?

Jones: Sure. Well, first of all, when you have a “price matters” discipline, what I want to distinguish it from is the traditional strategic where if you move 5% that might be a big deal. In 1999, when large-cap stocks got 100% overvalued, they dropped out of our portfolio entirely. In 2008, when commodities got to the 40% maximum overvaluation we've never seen, they dropped out of the portfolio entirely.

So, the great thing about the “price matters” discipline is it gives you the conviction to make big moves, but it's not sufficient because stocks got overvalued about 100% in June of 1999 and they kept going up for another nine months. So, you've got to add to it what we call “momentum process.” So, there is “price matters”--that's science--and then there is “momentum”--and that's more art, that's more measuring the shorter-term fluctuations in the market and then adjusting the longer-term strategy for those shorter-term market momentums. You can think of it as: We know we want to sell something--let's hold ourselves back until the market signals that it's ready to return to earth. We want to buy something--let's try to avoid catching the falling knife. Let's wait until the momentum of the market gives us the go-ahead signal.

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