Many of you have heard us talk about the rebalance we made to accounts back in June.  In this newsletter we would like to give you a few more details about how we determined those investments and how your money is invested.  Since everyone's case is different, there may be variations in the implementation, but the philosophy is the same.

We call our model the "Intrepid" model.  The model is composed of three investment categories: Equities, Fixed Income, and Alternatives.  Generally your investments will be invested in a third of each. 

Why This Mix?

When we put these investments in our optimization software, the mix that resulted was the best in terms of diversification, return, and volatility.  Had you invested in this mix in 2000 and followed all the trade signals you would have made over 15%/year when the S&P 500 index lost money.  Of course, there is no guarantee we can repeat that performance.  However, there is evidence from our software vendors that their optimization does provide excess return and we would hope the portfolio we created would also follow that trend.

Let's look at each category in detail.

Equities

Based on our research, we do not believe that dividing equities into Morningstar "Style Boxes" (see below) makes any sense.  Even though stocks may be in different "boxes", they tend to go up and down together (high correlation).

In fact, what we are finding is that correlation of equity markets worldwide is increasing, particularly in down markets.  So what was once a diversification strategy (buying different stocks around the world) is now not as effective.  We will pick stocks from all over the world and of different-sized companies.  We are not as concerned with volatility since, as trend followers, our systems help us control that by the use of cash.

We divide the Intrepid equity investments among four different managed strategies.  Three of the four are trend following, including our own global stock strategy.  We or the managers who employ trend following will enter and exit investments as the prices ebb and flow.  The idea is to capture some of the upside in a positive market and miss some of the downside when the market goes down.  Included in this list is a manger that made money in 2008 and still has been able to make about 85% of the gain when the S&P goes up. The non-trend following manager uses a dividend strategy that is currently yielding roughly 11%.

It is important to note that there will be times that our strategies will not be fully invested and hold a lot of cash.  This is on purpose and allows us to have cash available for when the trends eventually emerge.

Fixed Income

This category is divided among three different investments: a non-traded business development company that invests mainly in senior secured notes (yields 7.25%), a preferred securities mutual fund, and our own income model that uses trend following to invest in a number of bond funds.  We feel this is the best mix of liquidity and yield in this current low yield environment.  It also dampens volatility somewhat for the entire portfolio. 

Alternative Strategies

The main goal of this investment category is to provide non-correlated returns to the portfolio - so when things are going bad in the equity markets they may be doing well with these investments.  There are three main investments in this category: a global macro mutual fund, an arbitrage fund, and managed futures.  Correlation between these three investments and the S&P 500 index are 0.05, 0.58, and -0.22 (remember, perfect positive correlation is 1, no correlation is 0, and perfect negative correlation is -1).  The global macro fund makes trading decisions based on macro-economic conditions (i.e. will the Euro go down versus the Dollar).  This strategy is used by many hedge funds and historically has made single-digit returns with low volatility.  The arbitrage fund attempts to make money when companies merge.  They have provided steady returns through good and bad markets.  The managed futures fund uses a counter-trend strategy to produce results.  The best fact about the three is that not only are they not well correlated to the S&P 500 index, but they are not well correlated to each other (the highest being 0.13).

Ongoing Monitoring (Active Management)

We follow a weekly process in monitoring your investments in our proprietary stock and bond fund models.  The system reviews the data and signals trades based on mathematical probabilities. Generally we execute trades in the beginning of the week.  One advantage of using such a system is that we take the emotion out of the trade.  With fear and greed being the major drivers in the financial markets we feel that we have an advantage with a systematic approach.  It takes out the emotional connection and the issues that go along with that.  Since trades are based on mathematical probabilities, they are not perfect.  What we try to do is stack the deck in our favor and over time should outperform a buy and hold.

I hope this newsletter has given you an understanding of how you money is invested and a little on the creation and implementation.  As always, feel free to contact us if you have questions.

Finally, we are always interested in your feedback or suggestions.  Are there any topics you would like us to address in our newsletter?  If so, drop us a note or call.