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At Kinetic Financial, our philosophy is to identify emerging market trends and incrementally build positions in funds that demonstrate market leadership. In making our selection, we carefully weigh a fund's risk/reward profile over several time periods, including the past few months to a year or more. In assessing risk, we typically look at a fund's worst case drop (maximum drawdown) over last 1 to 3 years, as well as intermediate drops. To safeguard against a sharp reversal in trend, we make a small initial investment and then small increment investments as the upward trend of the fund persists. When the leadership trend reverses and the behavior of the fund changes, we incrementally reduce our position and update the fund recommendation accordingly (i.e. from Accumulate to Hold, then to Reduce, and finally to Liquidate).
This strategy works well with general market stability as we have seen during most periods in the past several decades. During a prolonged bear market, we protect a portfolio by tagging weak funds with a "Reduce" or "Liquidate" recommendation and we incrementally sell our weakest positions in the Model Portfolios. When a rally occurs, we reinvest the available cash in funds that emerge with strong Risk/Reward profiles (funds tagged with a recommendation of NewBuy or Accumulate). However, it typically takes time for a new trend to emerge and, therefore, we will tend to underperform the broad market during the initial part of the market rally. As the rally continues, we tend to catch up and surpass the broad market indexes by investing in funds with high alpha.
The market is currently going through rapid sector rotation. Money is moving from sectors that have over performed during the past several years to sectors that have underperformed. In a dramatic market divergence, over the last one month, several sectors/funds are up 10% to 20% while at the same time, some sectors are down 10% to 28% over the last 1 month. Financials, real estate, small caps, value funds, and the US Dollar, have dramatically rallied the past month but were underperforming during the preceding one year period (7/15/07 to 07/15/08). Over last 1 month, precious metals, energy, Latin America, Russia, utilities, and the Euro are down a lot but demonstrated market leadership over the preceding one year. This dramatic reversal happened on 7/15/08 - the day broad based US indexes reached a bottom. The broad US market is up significantly since that date while global markets as well as some leading sectors (energy, gold, utilities, and emerging markets) are continually making new lows.
We believe that the current rally in the US market is a bear market rally and cannot be sustained. The gains we've seen in the US are from sector rotation and not from sustained growth in the market. For a sustained market recovery to take place, most segments of the market have to recover at the approximately same time (although in different magnitudes). This has not happened in last one year.
In this schizophrenic market, it may appear that we buy funds at their peak and sell at their bottom; however, we only start with small positions. Therefore, if a small position quickly reverses trend and we bought at the top and sold at the bottom, the overall portfolio does not suffer significantly. Our objective is to make money on those few funds that demonstrate high performance over a longer period of time (12 to 24 months or more) where we incrementally build a significant position.
In this market climate, we continue a defensive posture. This will hurt us in the short term if the market rallies, however it will help us if the market declines further. We do not make decisions based on one month trends. Rather, we judge the Risk/Reward characteristics of a fund over the last few months, over 1 year, and the past several years to determine if it should have a "NewBuy" or "Accumulate" rating and be added to a portfolio.
Be patient; be defensive; watch the market; and capitalize on fruits of a sustained market recovery, whenever it may occur. The market always recovers, and that's the best opportunity to make money...
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posted by Ramesh Agarwal & Team @
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