2. As Paul Harvey, the great radio announcer, used to say, “And now you know the rest of the story.”
Wall Street is dominated by large institutions, also known as Broker Dealers, whose primary focus is
earning greater and greater earnings year after year. If you think about that for a moment, one must
understand these firms must close new deals, bring in ever increasing assets and make income
generating transactions to meet their goals. Unfortunately, history has shown the search for large
institutional deals which generate millions of dollars are in direct conflict with the interests of the retail
clients they also serve.
Modern Portfolio Theory (MPT) is a theory of finance that attempts to maximize a
portfolio’s expected return for a given amount of portfolio risk, or equivalently minimize risk for a
given level of expected return, by carefully choosing the proportions of various assets. MPT is
advocated by large financial institutions who seek to advocate Buy and Hold investing.
MPT is primarily delivered by computer. A brokerfinancial
adviser asks some questions and gains a feeling for the
investor’s risk tolerances. They then key into a computer, say,
moderate risk level and the computer spits out a Strategic Asset
Allocation pie created by all kinds of assumptions on future
interest rates, future market volatility, future returns on baskets
of stocks, and so on. You get it – future this, future that,
assumption this, assumption that, use a Monte Carlo simulation,
spin the wheel lots of times and voila, your strategic pie.
We believe this strategy is flawed since MPT assumes investors are rational and markets are efficient.
For MPT’s mathematical formula to work it assumes the correlations between asset classes are fixed,
even though history shows they are affected by “external events” like crises.
Guess what? In the year 2000 these
simulations suggested to investors that their
portfolios would grow at a rate greater than
10% for the next twenty years. How’d that
work out? The market caved in after the dot-
com bubble burst, 9/11 happened, and in
2008 the whole market melted down, all
asset classes together. Those computerized
guesses did not work.
As the graph shows, there have been very
different investment outcomes during the past
five decades. The 1960s, 1980s and the
1990s were a time when the conditions were
ripe for investing in equities. The rate of
return grew as the percentage ownership in
equities increased.
3. We all understand investing conditions do change; what seems to get lost in the process then is
that an investor’s investment allocation needs to respond accordingly. During the 1970s and 2000s our
economy suffered from uncertain times. Although there were a number of short term opportunities in
equity markets, the graph clearly indicates “Buy and Hold” investors were not rewarded for the
additional risk taken. Rather the 1970s and 2000s favored safety oriented techniques and bond
investors were rewarded.
There is another way to manage your assets
Although Modern Portfolio Theory suggests “don’t worry, things will be fine in the long run”, we
believe there is a large opportunity cost if you wait long enough for the bad stuff to ultimately turn
good. We call this thought process “Buy and Hope”, rather than the mutual fund branded phrase of
“buy and hold”. In fact, when you look at how the Large Broker Dealers and Investment Banks
manage their money, you will come to believe that Buy and Hold is not an investment strategy!
What does all this mumbo jumbo mean for you?
Typically when an investor sits down for “planning” purposes, an
advisor will suggest a traditional pie graph. The “pie” illustrates the
recommended Asset Allocation which defines the specific percentages
to be invested into different asset types reflecting your risk tolerance.
Your portfolio is then periodically rebalanced back to the target
percentages. For all intents and purposes the allocation percentages
remain static regardless of the market’s direction.
The theory to static asset allocation is if you spread your investment
dollars across several asset classes, risk can be reduced in the overall
portfolio. Recent history, however, has provided a number of
examples where the theory does not work; do you remember 1987,
1998, 2000, 2002 and 2008?
We are one of the few firms in the area which actively utilizes Tactical
Portfolio Management. We too follow a process of investing in
different asset types. Our intention though is to shift the weighting in
each asset class as investment conditions change. The percentages
invested will not remain static over time, rather the amount invested in
stocks, bonds and cash will fluctuate depending on current trends in the
various markets.
This strategy provides a systematic and disciplined way of
overweighting asset classes when they are in favor. It also provides a
way of transferring riskier assets into Cash Alternatives when there is no
better place to be.
4. Our Investment Methodology
We utilize technical analysis rather than fundamental analysis. The meltdown of 2008,
once again, proved that even fundamentally sound stocks will fall precipitously when more
investors are selling than buying shares, regardless of their fundamental pedigree.
The roots to our methodology date back to the late 1800's and have been proven effective in
both rising (bull) and falling (bear, or "fair") markets.
The first proponent of the methodology we use was Charles Dow, also the original
editor of the Wall Street Journal. Charles Dow recognized the merits of recording the supply
(sellers) and demand (buyers) relationship in any investment.
Our process embodies a set of rules that have been proven across many decades - in good
markets and bad - to serve as your "eyes on the road" for the financial markets.
Our investment decisions are made utilizing Point & Figure Charting.
The Point & Figure methodology has evolved over the past 100+ years, but remains at its core a
logical, organized means for recording the supply and demand relationship in any investment vehicle.
As investors, we are innately familiar with the forces of supply and demand; it is after all the first
subject introduced in any ECONOMICS 101 class. As consumers, we experience the supply and
demand impact regularly in our daily lives.
We compile a list of investments which represent
various assets in Domestic & International Equities,
Fixed Income (bonds), Commodities, Currencies and
cash.
We rank these assets from strongest to weakest in
performance based upon a Relative Strength (RS)
comparison.
Our computers perform thousands of calculations to
determine which assets have emerged as the leaders
according to our methodology.
As the assets fluctuate in strength, we will purchase the
stronger performing assets and watch for changing
market trends.
We use Point and Figure Charting (PnF) to track
the price movement of our investments in an organized
manner. Our goal is to ascertain who is winning the
battle of supply and demand (sellers or buyers).
