A: Ours is a five-step portfolio building process. First, we look at available funds in our core areas that include bond funds, REIT funds, mutual funds, index funds and ETFs. Next, these funds are run through our 39 screens. The third step involves allocation of the selected funds into the five essential themes; these include bonds, capital markets, energy, raw materials and real estate. In the fourth step, we divide our allocation equally between domestic and international securities. Finally, we distribute the funds between Index and FIVEX – based on whether they are index-based or managed. Index fund currently has over 10,000 underlying securities and FIVEX has around 3,000.

Q:  How many holdings do you have in your portfolio in the five areas and what is the minimum number you would hold?

A: We own more than 25 holdings and that is kind of a benchmark. We are trying to hold five different major asset classes, not just sectors. Unlike Wall Street, we do not think real estate is a sector. We may lower the minimum to 20 holdings; however, there are several different dynamics going on in this portfolio which require a broad diversification. So we prefer 25 plus positions in the portfolio not including our money market positions.

Q:  How would you define your buy and sell discipline?

A: Our buy/sell discipline is all about rebalancing the portfolios based on our performance metrics driven 39 screens. We have recently initiated daily calculation of fund performance in our holdings and fund universe of 20,000 funds. We have discovered that there is a measure of volatility that we can take advantage of with the daily NAV measurements compared to quarterly computations that we used to rely on.

The other time we buy or sell is as a result of our performance rebalancing exercise. We rebalance our portfolio with a proprietary mathematical model that keeps our fund from being concentrated in any one of the 5 themes. An example of this is that we take the spread of the highest performers such as, energy and raw materials against the spread of the lowest performer, which is real estate. We observe what happens if we rebalanced at 1% deviation between the themes, at 5%, 10%, 15% and more finally coming to a percentage point when we rebalance the whole portfolio.

Our buy decision is also because of the fact that we value performance in the down market more than in the rising market. We prefer to invest in a fund that is a steady performer in both up and down market than in a fund that shoots up one year and then lags the market in the next five years. We do not need to be the best performing fund in the up years, but want to be the number one performing fund or in the top 5% of the funds, during down years.

Q:  How do you manage risk?

A: We are in a transition to increase frequency of our portfolio performance measurement and NAV assessments from 4 times a year to daily. We believe that continuous risk monitoring and portfolio evaluation adds great value to our shareholders.

We do not hedge the portfolio by shorting ETFs or stocks. Our risk management is based on the premise that we are going to own five permanent positions and provide a core holding to our investors. We are a long-only fund so we sell positions if we find out managers we have invested with are shorting the market. We also do not believe in leveraged positions. If managers start using leverage to generate performance then we stop working with them.

Q:  How do 5 Essential Themes weather volatile markets?

A: As long-term investors, we understand that the markets will always have something to panic about, and should expect one or two such events per year. The key is to have an investment plan and to be able to ignore the day-to-day distractions that tempt you to deviate from it. The bottom line is that the type of market volatility you are seeing today emphasizes the need for a sound, longterm investment plan. The higher the quality of your investment plan, the higher your confidence level will be. The higher your confidence level, the greater your ability to ignore the day to day noise that tempts you to deviate from it.