Citadel Portfolio

> Momentum: A widely studied and proven variable that identifies asset classes that are likely to outperform in the future. The various asset classes are adjusted based on momentum.

> Macro-Economic: Portfolio risk allocations are adjusted based on macro-economic factors.

This dynamic portfolio, a product of years of research and our continuing market analysis, uses prudent tactical tools and macroeconomic indicators to optimize current asset allocation.

Momentum

The momentum anomaly is well known in finance and can be observed in all financial markets. It is nothing more than the tendency for rising asset prices to rise further and falling prices to continue falling. Research has shown, repeatedly, that assets with strong past performance continue to outperform assets with poor past performance in the next period. Optimal measurement periods can be different for different assets but all asset classes exhibit this behavior.

Mainstream economists find this momentum effect hard to explain because a change in price should not, in and of itself, warrant a further change. In an efficient market world, price changes are only warranted by changes in available information about the asset – in other words, by changes in fundamentals. At Alhambra we aren’t big fans of the EMH, primarily because of the existence of anomalies such as the momentum effect. While there is good reason to believe that markets are mostly efficient, anyone who lived through the dot com boom knows that investors do not always act rationally.

The Citadel portfolio takes the emotion out of the equation by employing a set of rules-based momentum adjustments. These momentum adjustments are applied within and between each asset class. Momentum adjustments will also default to cash in certain situations. Some examples:

Macro-Economic Considerations

The Citadel approach also considers the macro-economic environment. Recessions are fairly rare events but have a large impact on all markets. Identifying the onset of recession in advance is a powerful tool for adjusting asset allocation. We have developed a methodology for identifying these inflection points.

Any successful macro-economic adjustments to a portfolio must avoid false signals. Unnecessary trading increases costs and decreases tax efficiency. We avoid overtrading by limiting the indicators we use to gauge economic performance and the probability of recession.

The Citadel Portfolio starts with the sound strategic allocation of the Fortress Portfolio:

Citadel clients, in consultation with their Alhambra adviser, choose a baseline risk portfolio from 0% to 60% bonds. Our macro-economic adjustments will shift your allocation based on the economic outlook. If our indicators show a slowdown in economic growth, your portfolio will shift from the baseline portfolio to the next, more conservative allocation:

If our indicators show an acceleration of economic growth, your portfolio will shift from its current allocation to the next more aggressive allocation:

The adjustments can be more extreme when our indicators show a high probability of imminent recession or an approaching exit from recession.

Economic growth will slow and accelerate multiple times through the course of a business cycle. Sometimes the change will be small and other times quite large but the Citadel portfolio is not designed to catch every minor change. Most of the time your portfolio will be invested in your baseline allocation.

Our Indicators

These are some of the indicators we use to judge the current state of the economy:

> Yield Curve: The yield curve – the difference between short and long-term interest rates – has been identified through numerous research papers as the most accurate indicator of future economic growth.

> Credit Spreads: Credit spreads – the difference between junk bond and Treasury yields – are also predictive of future economic growth but must be used in conjunction with the yield curve to provide actionable information.

> US Dollar: The trend of the dollar provides insight into global capital movements. Countries that are performing well economically will generally have stronger currencies than those that are not.

> High-Frequency Economic Data: We analyze every economic report for trend purposes.

The Citadel Portfolio starts with the asset allocation of our original Fortress Portfolio. The portfolios are constructed using ETFs and/or mutual funds for each asset class in the Fortress allocation. Half of the Citadel Portfolio will always be in this strategic allocation. The other half of the portfolio is tactically adjusted using our momentum rules. Finally, the macro-economic indicators above are used to toggle around the baseline portfolio. In this way, we have mulitple methods of adjusting the portfolio to current market and economic conditions.

It is this combination of a diversified strategic plan – the Fortress Portfolio allocation – and intelligent tactics, that together produce a dynamic, tactically adjusted Citadel Portfolio.

The Citadel Portfolio, the end result of our extensive research on the global economy, is designed to grow wealth in a structure that prioritizes safety and security. The strategic framework of the Fortress Portfolio provides a more consistent result than the traditional stock and bond portfolio making it ideal for pre-retirees and retirees. The tactical changes seek to improve on the already impressive track record of the Fortress Portfolio.

Customization

The Citadel Portfolio can be customized to reflect your strongly held views. Tell us about your views or concerns and we can probably address them.

Example: The Citadel is constructed with a domestic (US) version of the Fortress portfolio. If you feel strongly that you do not want a US emphasis, we can construct a custom Citadel that uses an international version of Fortress as the base.

The Citadel Portfolio – Your fortress against market storms.