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The market volatility is at unprecedented levels. For our personal and client portfolios, we're recommending a market exposure of about 30%. This way, even if the market goes down another -50%, the loss in your personal portfolio will only be about -15%. On the other hand, if the market rebounds, you'll have enough meaningful market exposure to take advantage of the recovering market and can increase your market exposure along the way. Please remember, nobody can predict the bottom of the market. Our model portfolios are meant to model the equity portion of your portfolio. We need to keep the model portfolios almost entirely invested in the market at all times to compete with the indexes over short time periods (otherwise excess cash would cause a drag on the performance in a recovering market). If you look at our September recommendations, we bought SPY (S&P 500) and EFA (international market) to keep exposure in the market in case of a market rally but with a bearish outlook. In this type of market environment, it is difficult to screen for new funds because there is no rhyme or reason to the market. You can't make smart decisions because the market is completely irrational. There is a daily tug of war in the market between fear and greed. The funds we have in the model portfolios are good and we are watching them on a daily basis. In general, the volatility index (VIX) must go down before rational decisions can be made in the market. Until that time, there is a 50% chance that any fund (or the market) will go up or down on a daily basis. Therefore, we are holding our positions with less activity at this time until the market volatility diminishes and we can make rational assessments of the funds we own compared to all the other funds that exist in the marketplace. Please keep communicating and feel free to send us an e-mail if you have any questions.
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posted by Ramesh Agarwal & Team @
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 @
Last week we discussed some key concepts in personal portfolio management.
The three most important metrics to track for your personal portfolio are:
- What was the peak value of your liquid portfolio?
- What percentage have you dropped from your peak?
- What is your equity exposure (total equity value divided by total portfolio value, including cash and bonds that are held to maturity)?
If you are dropping too far from your peak past a certain threshold for normal market volatility, say -5%, perhaps it's time to incrementally reduce your equity exposure to reduce your risk and protect your assets from an extended bear market. You can reduce your equity exposure by selling your funds with a "Reduce" or "Liquidate" Kinetic Financial recommendation. The rate at which you reduce your equity exposure relates to your personal risk tolerance.
Similarly, if your total liquid portfolio is increasing from its bottom (past a certain threshold- say +5%), perhaps it is time to increase your equity exposure by buying funds in the best areas of the market from a Risk and Reward perspective. You can increase your equity exposure by buying funds with an "Accumulate" or "New Buy" Kinetic Financial recommendation.
This strategy will help you make money in the best areas of the market during *sustained* market upturns and protect your assets during an *extended* bear market.
As we discussed previously, the Kinetic Financial Model Portfolios are tuned to assume "market" risk as defined by the S&P 500. If you are willing to accept this level of risk for your portfolio, you can follow the model portfolios exactly.
Regardless, we believe it is very useful for everyone to track their portfolio using the three simple metrics described above.Labels: portfolio management
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posted by Ramesh Agarwal & Team @
As you already know, the market has been in a steep decline since last October. During this time we have managed risk by reducing our exposure to underperforming funds, especially in Small Cap and International markets. Weighing the risk of a further market drop against the risk of missing out on a big rally, we have increased our exposure to better performing funds, especially in Consumer Staples, Utilities, and Large Caps.
It is important to realize that the Kinetic Financial Model Portfolios must be predominately invested in the market at all times in order to compete with the broad indexes during short time frames. In other words, the Equity Exposure of the Model Portfolio (total equity value divided by total portfolio value, including cash and bonds that are held to maturity) must always be close to 100% in order to complete with the indexes during 3-month, 6-month, and 12-month time frames, especially during market rallies.
Since the Kinetic Model Portfolios are almost always invested in the market, it will have market risk characteristics which may be undesirable to the investor from a risk tolerance perspective. For example, the S&P and the Kinetic Financial Model Portfolios lost about -18% from their peak in Oct 2007. Taking on this much risk may not be suitable for an investor depending on their risk tolerance.
For this reason, for our personal portfolios, we very carefully track our Equity Exposure to ensure it is inline with our personal risk tolerance profile. We also carefully track the peak value of our portfolio and the % we have dropped from our peak value. If we drop too far from our peak portfolio value beyond our comfort level, we can reduce risk and Equity Exposure by sell selling our weakest positions. On the flip side, if we start making money from our portfolio, perhaps we may be willing to increase our Equity Exposure (and risk) by buying funds in the fast growing areas of the market from a Risk and Reward perspective.
In this way, the Kinetic Financial Model Portfolios help us to manage the equity portion of our portfolio, but this is only one dimension of success portfolio management.
The main point: you may not want to be 100% invested in market the way the Kinetic Financial Model Portfolios are based on your personal risk tolerance.
We will discuss more concepts in portfolio management, equity exposure, and risk management next week.Labels: Risk Management
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posted by Ramesh Agarwal & Team @
On Sunday night we issued a SELL recommendation for MGLBX which was executed at the end of the day on Monday. The market had a sharp rally on Tuesday.
In general, our recommendations are designed to (1) make money during sustained periods of growth and recovery (2) protect assets during an extended market correction. Since we are still in an extended bear market correction, our bias is to protect our assets rather than make money on short term volatility.
Please do not get caught up in the emotions of the market. You could be thinking "Why did Kinetic Financial tell me sell an investment one day before a sharp rally... I've lost money because of their recommendation!"
Smart investment decisions are made by being systematic instead of emotional. Nobody can predict the future. Instead, we react to changes in the market by either selling our weakest assets during a downturn or buying the strongest assets during an upturn. We do not, and will not, make money from short term volatility. Instead, we seek to make money during *sustained* periods of recovery and growth.
Currently, the Model Portfolios are in line with overall market risk. Please track our model portfolio performance statistics over time and you will see that our fund recommendations are valuable. We are confident that our model portfolio performance will be substantially better than overall market indexes over the long run. When the market starts to recover, we will generally under perform in the short term while re-deploy our cash. However, we will generally catch up and surpass the indexes by investing in the strongest areas of the market and in funds that have high alpha.
Please send an e-mail to feedback@kineticfinancial.com if you have any questions.
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posted by Ramesh Agarwal & Team @
Happy New Year and thank you for your support! 2007 turned out to be a good year for Kinetic Financial. Our Large Model Portfolio returned 11.3% compared to 5.5% for the S&P! On average, the Small, Medium, and Large model portfolios returned 10.9% in 2007.
Our performance will generally be some weighted average of the S&P, MCSI EAFE (International index), and MSCI EM (Emerging Markets index), depending on which of these indexes perform the best from a Risk and Reward perspective. During a shift in market leadership, such as the one we experienced starting in February 2007 (market leadership shifted from Small Cap Value to Large Cap Growth), we will tend to under perform the broad market indexes as we redeploy our investments. However, if market leadership remains stable for sometime (6 months or more), we will tend to catch up and surpass the broad indexes by recommending and investing in funds with high alpha compared to the broad indexes.
So, was all the Kinetic Financial buying and selling activity in the Model Portfolios worthwhile? You could look at any individual fund that we recommend (MMUCX, ADINX, THOIX) and say "hey, I would have done better if I invested all my money in any one of these funds!" Or, you could say "hey, I could have done just as well if I invested all my money in EFA which tracks the international index."
Our belief is... absolutely yes! It was absolutely worthwhile to have the buying and selling activity in the Kinetic Financial Model Portfolios. Why? Here are a few reasons:
1) Hindsight is always 20/20. The question is not "Where should I've put my money 12 months ago to get the best return?" Rather, the correct question to ask is "Given all the information I have today and the state of the market as it exists today, where do I have the highest possibility of making a good return with low risk over the *next* 12 months?" This is why our tag line is "mutual fund recommendations for the prevailing market conditions." We try to determine the state of the world today without making any predictions for the future. When tomorrow comes, we re-evaluate our recommendations to see if the state of the world has changed. Our goal is to spread investments over many high performance funds that appear to have good Risk/Reward profiles. If a fund changes behavior (does not conform to its recent risk and reward characteristics), we sell it. If a fund continues to exhibit the same behavior over time, we continue to accumulate positions in the fund.
2) We reduce market exposure during down markets by selling our weakest positions which protects us from an extended bear market. During the February & July 2007 downturns, we were almost 30% in cash. History has shown us that during person's lifetime, very large market corrections *will* occur. The NASDAQ lost 78% during the 2000 technology bubble burst; during the Great Depression the stock market fell 86% over a 34-month period; and finally, after the 1973-74 market plunge, the market did not recover for more than 7 years. By definition, indexes are always 100% invested in the market. Most mutual funds must remain close to 100% invested in the market to compete with their benchmark indexes during short time frames. Therefore, it is up to us to control our market exposure in the event of an extended bear market. Selling weak positions and adjusting market exposure gives you complete control of your downside risk. For me, knowing that I won't lose my shirt no matter what the market does helps me sleep at night.
3) No single fund can have high performance forever. Good funds tend to have a lifecycle. If a fund has good performance, eventually people catch on and assets are attracted to the fund. Then, the fund experiences asset bloat and the strategies that made the fund successful in the first place often don't work anymore-- the fund begins to behave like the index. Smart fund managers that are not greedy tend to close their funds to new investors to keep assets at manageable levels. So, the trick is to identify high performing funds early enough in their lifecycle before they close their doors to new investors. When we recommend buying a fund, we know that someday we will need to recommend selling that fund because the money will be better elsewhere. We don't know if the behavior of the fund will change in 1 month; 3 months; 12 months; or 5 years. However, we keep this uncertainty in mind and try to invest in funds with low transaction costs and high liquidity.
4) Our portfolio allocation automatically shifts to keep it in line with market leadership. At the beginning of 2007, our portfolios were heavily invested in Small Cap Value funds which have had great run during the past several years. Now, we are mostly invested in Large Cap Growth funds. Small Caps lagged recovery after the February, July, and November 2007 downturns. As a result, we redeployed our cash into the fast growing areas of the market which was demonstrated by Large Cap Growth and International funds.
5) Our model portfolios are scalable to help you manage 100% of your wealth. Yes, you could have made 50% in 2007 if you invested in Google, but would you have invested 100% of your net worth in Google? Even if you use Kinetic Financial to manage millions of dollars, your ownership stake in any single stock will most likely be a fraction of a percent based on the mutual fund stock holdings. This allows for incredible diversification. Also, we provide additional downside protection because we reduce market exposure during down markets.
6) We boil the ocean of funds out there down to a cup of tea. You may think "hey, this fund that I've invested in looks pretty good but Kinetic Financial does not recommended it." Yes, but we are screening almost every fund that exists in the marketplace-- over 17,000 unique fund symbols. If it's on Morningstar, we've screened it. If your fund didn't pass our screening algorithm, it's probably because of its Risk profile relative to its performance weighted more heavily on the most recent market downturns. We will always gravitate toward high performing funds that have demonstrated less risk in the most recent market downturns.
7) If you take $100,000 today with a compounded rate of return of 10%, you'll have $1.7M after 30 years. If you take that same $100,000 today and achieve a rate of return of 15%, you'll have $6.6M after 30 years. It's worth fighting for those few extra percentage points of return every year! That's the power of compounded returns. If you look at our performance track record, you'll see that we generally beat the broad market by 5% to 10% year-over-year. That's with downside protection! Past performance does not guarantee of future returns. However, this year we were able to achieve our personal target performance objective of 5% to 10% over the broad indexes.
Thank you everyone for your support. May 2008 bring you happiness, joy, and sunshine. Please add a comment if you have any questions. Even if you don't have a question, your positive (or negative) feedback would be appreciated.Labels: model portfolio performance, Mutual Fund Recommendations, Track Record
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posted by Ramesh Agarwal & Team @
The market appears to have started a recovery. All of the major indexes are up over 5% from their bottom. However, it remains to be seen if this market recovery is sustainable.
The Kinetic Financial model portfolios are currently 25% to 35% in cash to protect us from an extended bear market. As the market recovers, we will incrementally put this cash back into the market by investing in funds that held up well during the most recent market downturn and at the same time have demonstrated good performance.
It is during down markets that good funds reveal themselves. We look for funds that have lost the least amount of money during the most recent market downturn but have still demonstrated high upside potential. If the same issues continue to plague the market in the near future, we'll be better protected by investing in funds that have demonstrated less risk in the most recent downturn.
Be on the lookout for our new fund recommendations as the market recovers. We never make big bets on any one fund. Instead, we incrementally build up positions in funds that continue to demonstrate strong Risk/Reward behavior over time.
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posted by Ramesh Agarwal & Team @
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