We Apply Our Philosophy Through a Proprietary Multi-Step Process

The central thesis to our investment process is that certain key factors associated with individual stocks dictate their long-term returns. Or to put it another way, stocks that possess certain key factors that historically have been associated with superior returns have a strong likelihood of future outperformance. Accordingly, we use this framework to craft stock investment strategies that have a high likelihood of outperforming the market due to their significant factor advantages.

To reduce overall portfolio risk, we combine our factor models with proprietary market-timing hedges as a portfolio overlay. By operation, these tactical hedges seek to reduce portfolio risk by limiting stock market exposure when the current market environment suggests that the risk of owning stocks is high, while keeping the portfolio fully invested in stocks when the market environment suggests that the risk of owning stocks is moderate to low.

Identify Key Factors

We start by using internally created research and third-party data to identify certain objective factors that historically have been associated with superior stock performance. These factors can be broadly categorized as being based on a stock’s value, quality, volatility and price momentum.

Strategy Development and Implementation

Once we have identified the key factors associated with stock outperformance, we use them as a framework to create our stock investment strategies. These strategies are then implemented based on the following process.

Identify Stock Universe

Our strategy implementation process begins with identifying the applicable stock universe from which we select the stocks with the most favorable prospects. Each stock universe that we build takes into account certain key requirements such as a stock’s size, liquidity and location of exchange.

Apply Initial Factor Screen

Within the applicable stock universe, we apply our factor-based models to remove from consideration any stock whose factor profile suggests poor future returns. For example, at this stage, depending on the specific strategy, we look to exclude any company that may be overvalued or has exhibited poor financial and/or operating performance or excessive historical price volatility. Our goal here is to avoid bad companies whose stock may be in jeopardy.

Stock Selection

After we have identified those stocks with the most favorable factor profiles, we then rank them based on one or more individual factors such as the stock's valuation, quality, price momentum and/or historical price volatility. Depending on the specific strategy, those stocks with the best valuation, quality, price momentum and/or low volatility factor characteristics are then selected for inclusion in the portfolio, subject to a maximum sector exposure rule. Our goal here is to identify and select those stocks that have the highest probability of future outperformance.

Portfolio Construction

Depending on the specific strategy, the selected portfolio stocks are then either equally weighted, market cap weighted, fundamentally weighted or weighted based on their inverse-volatility. The portfolio is also remodeled and rebalanced at least annually.

Risk Management

To provide downside protection against major market declines, the majority of our strategies incorporate a proprietary market-timing hedge as a portfolio overlay. These tactical hedges are designed to reduce portfolio risk by moving the portfolio into U.S. treasury bonds when the current market environment suggests that the risk of owning stocks is high and seeks to keep the portfolio fully invested in stocks when the market environment suggests that the risk of owning stocks is moderate to low.

It is through this systematic investment process that we build and manage our client portfolios in order to maximize factor exposure so as to increase the probability of portfolio outperformance while also seeking to protect our clients from substantial market declines.

OFFICE LOCATION

1729 King Street
Suite 310
Alexandria, VA 22314
P: 703-740-1765
E: info@mercapitalmanagement.com

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