Investing is hard. We want to make it easier.
We believe there are two main types of risk investors face: market and behavioral. Through Discipline Funds, we seek to minimize both types of risk by instilling behavioral discipline through systematic portfolio allocation. Put simply, the philosophy at Discipline Funds is to reduce potentially volatile swings in an investor’s portfolio while maintaining an investor’s market exposure.
We believe in low cost index funds. However, we think that “traditional” index fund strategies can be improved. Using the popular 60/40 stock/bond portfolio as an example, some potential flaws we hope to address are identified below:
1. Pro-cyclical stock risk creates behavioral risk. Most index funds (such as a 60/40 stock/bond index) rebalance pro-cyclically, with portfolio volatility driven by the stock allocation, which is rebalanced back to its 60% weight regardless of relative market risk. For example, a 60/40 portfolio in 2008 is much riskier than a 60/40 portfolio in 2010. In 2008, a 60/40 portfolio fell 30%+, which was an alarming decline for many investors. This can lead to behavioral risks such as exiting the market during a market drawdown, or, on the flip side, feeling irrationally protected during a market “boom.”
2. Inefficient tax and liquidity management. Holding a 60/40 index may involve tax inefficient withdrawals and rebalancing if an investor has to sell some of the individual fund or a more aggressive holding to meet liquidity needs or manage one’s risk profile. Holding the Discipline Fund enables an allocation around the Fund that can meet short-term liquidity needs while also holding a more aggressive piece if appropriate. The Discipline Fund aims to systematically rebalance away from the predominant trend in its surrounding holdings, minimizing the need to rebalance the portfolio as a whole. This allows a more efficient portfolio allocation that not only maintains an appropriate risk profile, but also helps manage the tax efficiency of liquidity needs and rebalancing.
3. Inefficient bond allocation. We believe the 40% bond allocation in a 60/40 portfolio often does not adequately hedge the stock allocation because it’s too small when the stock market is at its riskiest and the bond aggregate is too short in duration on average (holds too much cash and cash equivalents). This is exaggerated in a low interest rate environment when the short duration instruments have low yields and provide limited/no principal appreciation when interest rates decline. The Discipline Fund seeks to address this issue by rebalancing countercyclically and holding only high quality corporate bonds and longer duration high quality US government bonds during periods when the stock market is most likely to to be volatile.
We believe the Discipline Fund offers simple answers to some of investing’s toughest problems. We also believe that smart investing doesn’t need to come in an overly complicated wrapper. That’s why we offer our strategy through a single, systematic, low cost, globally diversified ETF, available to all.