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What's In My Model Portfolio
Johnson Financial Group CIO Dominic Ceci RIA news model portfolio
Johnson Financial Group CIO Dominic Ceci

Johnson Financial Group: Rules-Based Rebalancing and Phasing Out Cash

JFG’s CIO Dominic Ceci discusses the $10 billion RIA’s rules-based rebalancing approach, the opportunity he sees in reinsurance, and the decision to phase out the cash allocation over the next year.  

Johnson Financial Group, the largest family-owned SEC-registered investment advisor in Wisconsin, with approximately $10 billion in assets under management, has a long history. It was founded as a bank in 1970 by Samuel C. Johnson, the fourth generation of his family to lead S.C. Johnson & Son, a multinational corporation based in Racine, Wisc., that makes chemical-based consumer goods. Today, the financial services company comprises the bank and RIA.

Earlier this year, the RIA appointed Dominic Ceci, a senior vice president and director of portfolio management and trading, as its new chief investment officer. He replaced Brian Andrew, who left to serve as CIO of Merit Financial Advisors. Ceci now leads the investment committee at the storied firm while also overseeing investment decisions and trading operations.

what's-in-my-model-portfolio.jpgHe recently gave a look inside JFG’s core model portfolio, which includes a 15% allocation to alternatives. He also discusses the firm’s rules-based rebalancing approach, the opportunity he sees in reinsurance, and the decision to phase out the cash allocation over the next year.  

The following has been edited for length and clarity. What’s in your model portfolio?

Dominic Ceci: Right now, 32.6% of the model is in large cap U.S. equity. In the SMID [small/midcap] bucket, we’ve got 6%; in international equity, we’ve got 16.4%; and then in fixed income, 29.2%. Alternatives are 14.9%, and the money market is 1%.

In the equity sleeve we do a mix of active and passive. And most of the passive is going to be in large cap U.S., and then we’re looking at active in SMID U.S. In international, we liked active a lot, but there’s a little bit of passive in there as well. In fixed income and alternatives, we tend to use mostly active managers

We don’t really like to make a big bet on value versus growth. Those cycles are pretty hard to predict. Value has been losing for quite a while now, so we’re pretty neutral on that and position with the market there.

Fixed income is an area where I think we’ve got a really good process, and we’ve got a really good team that can figure out what’s going on. We do a lot of relative valuation in fixed income, and manager selection has worked out well for us in the past there too. We’ve been very successful in the fixed-income sleeve over a pretty long time period, so we do a lot more in that sleeve.

Part of it is that the benchmarks end up missing a lot. If you buy the Agg, you get a ton of just government stuff there, and there’s a whole bunch of other ponds to fish in that you just miss if that’s all you're doing. So we like to pick some pretty good active managers and then let them fish in some of these other ponds.

WM: How is the alternatives bucket allocated? What do you see as the opportunity in that asset class?

DC: We’ve liked private credit for a while, and we’ve got the Cliffwater fund that we’ve been using for quite a while there. Real estate’s really gotten crushed for a while now, and we’ve had an allocation there. It’s a long-term allocation, but we’ve been a little bit overweight for a while, and we're probably adding to a position that’s not in the portfolio here. Sometime in the next month or two, we’d be allocating to reinsurance, or catastrophe bonds, so that will get funded out of the existing positions there.

Reinsurance is probably the most interesting opportunity at this moment. For our clients that are deploying new capital into limited partnerships and that kind of thing, real estate is pretty interesting right now as some of these distressed real estate funds are spinning up given what’s going on there.

WM: What are catastrophe bonds?

DC: As an example, if you live in Florida, you’ve got to get homeowners insurance, and you get that through your insurance company. But then the insurance company has to also get insurance because they can only take on so much risk, And so they have to reinsure themselves. And so there are some of these really big companies that help manage some of the risk from these insurance companies. If a hurricane comes through and has major damages to the area, that’s when these reinsurance types of things have to pay out.

Part of the reason for the interest is that it has no real correlation with equity markets or fixed-income markets. It’s based on how they’re writing the insurance policies and then what the outcomes are in the weather in the next year or so. So we’re coming off a period where the way that those policies were written, the pricing is pretty favorable, so that works out well if you’re an investor there. You always expect that there’s going to be bad weather, and unfortunately, there’ll be some hurricanes and things like that, but because it’s being priced the way that it is, there’s a pretty big buffer there.

We’ve got a fund that we like that’s got daily liquidity with a manager that’s been doing it for a long time and had a lot of success.

WM: JP Morgan CEO Jamie Dimon recently warned against retail investors’ entrance into private credit and said there could be “hell to pay.” What are your thoughts on private credit?

DC: With private credit, I understand why some people would have some concern because it’s a newer thing. It’s a very quickly growing market, but that’s a function of other areas where these companies would have gotten access to that capital basically drying up. Banks aren’t giving it to them anymore.

I’ve seen some research showing that money is flowing back the other way because the spreads on private credit have gotten big enough to where it’s now economical for some of these firms to go back to just the standard broadly syndicated loan market and just issue high-yield bonds again. So I think some of this money that’s flowing into private credit will probably move back the other way.

We’re going to be adding a position to reinsurance, so we will be reducing our weight to private credit.  But that’s not because we don’t like private credit; it’s because we like the opportunity in reinsurance.

WM: How much do you hold in cash? Why hold cash?

DC: We’ve got 1% of the portfolio in cash, and like a lot of places, it’s mainly for client liquidity needs. But we’re actually working on phasing cash out of the model in the next 12 months.

The way we would do that is, we can do cash management strategies that are specific to each client and their actual needs, which creates more work on our end, but it will get better results for the clients. That will make the model portfolio look a little bit different because that cash allocation will go away, and then that would just get reallocated back into fixed income, which is where it comes from.

There are some clients that really won’t have any; a Roth IRA account is a really good example where those tend to be growing, and they’re not distributing. So people are adding money to them each year. And a lot of times, clients will have fees come out of a different account because they don’t want to take out a tax-deferred shelter. Sometimes we’ll have literally no cash needs in an account, and we want to be mindful of that. It just becomes a very custom solution for each client.

WM: Have you made any big investment allocation changes in the last six months to a year? If so, what changes?

DC: The most significant change that we made in recent months was a strategic shift to how we fund the alternative sleeve. So, that 15% in alternatives target has been consistent, but with the forward returns and fixed income being much more appealing today than they were a couple of years ago, we moved our alts funding to an equal 50/50 split from equity and fixed income. We used to take basically 5% from equity and 10% from fixed income, and then you get your 15%; now we take 7.5% from each. With interest rates in the 3% to 5% range, fixed income just has a lot better forward returns than it used to.

WM: What differentiates your portfolio?

DC: We’re in the sweet spot from a size standpoint. We’re big enough that we can get our clients access to the best managers, but we’re not so big that we’re going to flood the smaller boutique managers that we like. That’s a strength for us.

Our process is also a differentiator. We’ve got a good, disciplined, rules-based rebalancing process, and we probably spend more time than average thinking about rebalancing. It’s an area that often gets overlooked. Sometimes people just use a calendar rebalance or something like that, and there’s a lot more that goes into it on our end.

Now, we do tax loss harvesting, so you do have to be aware of the calendar for that. But just from a sheer rebalancing process, we’re not just going to rebalance every quarter just for the sake of it. There has to be a reason. We track where the portfolio is moving. If we drift too far outside of a range, then that can trigger rebalancing, but we don’t want to rebalance too soon because you do want to give things some room to run.

We’ll also pay attention to what the markets are doing. We actually have very specific rules around when we’ll rebalance the equity sleeve. For example, if markets are extremely volatile, then we have rules where we have to rebalance at certain thresholds and then sometimes even rebalance and add to the equities because we know that, as long-term investors, those moments can be scary. But long term, we feel pretty good about the allocation to equities. That’s worked out for hundreds of years, so we can take advantage of those when you’ve got those pretty big drawdowns. Those tend to be pretty emotional moments, so we use rebalancing as the way to offset the emotion in that moment. Tamarac provides our rebalancing tool.

WM: What investment vehicles do you use?

DC: We use a combination of mutual funds, ETFs and interval funds. But the vehicle is a secondary consideration. We’re focused on finding the best strategies to get us the exposure we want, and then we’ll consider the wrapper after that fact. We’ve started to see more and more that some of these managers and strategies are offered in multiple vehicles, so you might have a mutual fund and an SMA. Or we’re now starting to see a lot more active managers launch ETFs, which is a really good development for clients, especially. In some of these instances, we’ll have both the mutual fund and the SMA as an option, so if the client meets the requirements to use the SMA, then we will use that.

WM: You mentioned tax loss harvesting. Does that mean you use direct indexing? Do you use an asset manager or tech provider for that?

DC: We do internal tax loss harvesting just at the portfolio level, and we do that throughout the year as it makes sense. If something is at a material loss, we’ll take that loss and flip it into a proxy for 30 days and then move back or move to wherever we need to go. If we’re using SMAs, those managers do it on their own.

We do have a direct index option available. Right now, Parametric is the direct index provider that we use, so some clients might choose to sub that in for the core large cap holding. What would you use that for?

DC: Most of the utilization has been for the ESG piece. The way that Parametric works, you can pick the values you want to have either screened out of that portfolio. And so that’s been a pretty common use at this point.

WM: What’s your due diligence process for choosing asset managers or funds?

DC: We start with quant screens to narrow the universe, and then from there, we’re going to choose 10 to 15 managers, and the research team will do a deep dive on those. That could lead to a recommendation, or it could not. Sometimes they do the deep dives, and they find some things that are interesting and that just has us following up for a while before we determine if a recommendation is warranted. So there’s a watch list, let’s call it, that can develop from that process.

If an analyst gets to the point where they’ve made a decision to recommend, then they’ll pitch the manager to the investment research team who can either approve or deny the recommendation. And then, if the strategy is approved, it gets put on the approved list for use by the client-facing portfolio managers, and it could possibly end up in the model. And then once something is approved, that team obviously maintains ongoing coverage for a manager.

WM: Do you have any interest in cryptocurrencies or Bitcoin ETFs?

DC: We’re interested observers but not interested as investors at this time.

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