When it comes to investing, we now live in a time of information overload, what with numerous financial channels on TV, endless investment advice on the Internet and hundreds of newsletters and other publications related to the markets and where to put your money. All of these services focus on where you should invest your money now to make the best returns.
Yet rarely do these services talk about how to avoid large losses. Furthermore, many times these services simply ignore their recommendations and advice that led to large losses in the past. But I can tell you that the cornerstone of successful investing is avoiding big losses of your capital. In order to do this, you must place more emphasis on the risks associated with your investments than on the possible returns.
For decades, Wall Street has advocated a “buy-and-hold” investment strategy for the stock markets. In this strategy, you buy a portfolio of stocks and/or mutual funds and simply hang on through thick and thin. However, in the bear market of 2000-2002, we saw the S&P 500 Index fall 44%, and the high-flying Nasdaq Index plunged over 70%. Investors who suffered those losses may never make back all that they lost.
On the following page, I have included a “breakeven table” that shows just how hard it is to recover from large losses. A 50% loss, for example, requires a gain of 100% just to get back to breakeven. As you will see, avoiding large losses should be objective #1 in your investment strategy.
This week, I will introduce you to the latest professional money manager who has made it into our recommended list of Investment Advisors. This manager has a stellar record of outperforming the stock market over the last ten years, and more importantly he even managed to make money during the bear market of 2000-2002. This is one professional equity manager that you definitely want to take a look at.
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Avoiding Losses Is Objective #1
There are some investors who are of the “no pain, no gain” school of investing, that figure you have to take a lot of risk to get above-average returns. Even after the bursting of the tech bubble a few years ago, these investors still insist that you have to take a lot of risk in order to make good returns and meet your financial goals.
The problem with this approach is that while they may be able to get above-average returns along the way, they also subject themselves to the potential for severe drawdowns in value. When this happens, it takes a much higher return to get back to where you were before the loss was incurred. For example, if you lose 20% in the market, you have to earn 25% just to get back to breakeven. The table below illustrates this idea more clearly:
Amount of Loss
To Break Even
Note that if you lose 30%, you have to make almost 43% just to get back to breakeven. Lose 50% and you have to make 100% just to get back to breakeven. The table above should clearly illustrate to anyone reading this E-Letter why I believe that avoiding large losses is the most important objective of any worthwhile investment strategy.
Wall Street’s “Buy-And-Hope” Strategy
As noted above, the conventional thinking on Wall Street is that you buy a portfolio of stocks or mutual funds and you hold them for the long-term. Of course, we all know that a buy-and-hold strategy means that part of your portfolio will go up and down in value as the stock market goes through its cycles. That’s why we call it the “buy-and-hope” strategy – hope the market goes up, that is.
Seriously, a buy-and-hold strategy certainly has a place in a well-diversified portfolio. But if you have been reading these weekly E-Letters for long, you know that I also believe most investors should have a portion of their portfolio invested with active money managers who have the flexibility to exit the market and/or “hedge” their positions should we go into a prolonged downward correction or a bear market.
The main goal for such active management is to reduce losses during market downturns while at the same time participating in market gains in the good times. While the number of money managers who can do this successfully is rather limited, they are out there if you know where to find them.
We have recently found yet another professional money manager that has met all of our stringent requirements. Most importantly, this Advisor even made money for his clients during the bear market of 2000-2002. Now that’s impressive! I’m thrilled to introduce you to Scott Daly.
Introducing Scott Daly’s Asset Enhancement Program
As you might guess, overall risk is a major consideration when my company evaluates professional money managers for our clients. Most Advisors we review do not provide significant risk reduction, but some have track records that combine good performance with excellent risk management. One such Advisor is Scott Daly.
From January of 2000 through December of 2004, Scott’s Asset Enhancement Program delivered a positive annualized return of 15.89% with a worst drawdown of less than 1%. That’s right, the Asset Enhancement Program limited drawdowns to less than 1% during one of the worst bear markets ever. (See complete performance information below.)
The story of how Scott Daly came to be a money manager is one of the more interesting ones we have encountered. By the time he earned his B.A. in education from Queens College in New York, he had already abandoned his original plan to become a teacher. During a student teaching assignment in his senior year, a group of unruly junior-high students showed him that being an educator was not to be his life’s calling.
After graduation, Scott went into the real estate business in Manhattan, where he excelled during a stellar 15-year career. His opinions on New York real estate were widely quoted, and he was named the “Most Honest and Hardworking Agent In New York.” Needless to say, Scott accumulated a significant net worth from his successful career in real estate.
As a result, Scott investigated a number of professionals to help him manage his assets. As fate would have it, his real estate partner married Herb Friedman, a long-time Investment Advisor who employs active management strategies. What started as an Advisor/client relationship between Scott and Herb soon developed into a business association, and a new career for Scott. He quickly learned the details of actively managed strategies, and then started making adjustments to the models based on his own observations and analysis.
In 2001, Scott decided to strike out on his own with the active management strategy he had developed. Since Scott is essentially a one-man shop, he initially joined an existing Registered Investment Advisor firm in New Jersey. That firm provided needed back-office operations for Scott’s money management activities.
In early 2005, however, he formed another business relationship with Purcell Advisory Services in Tacoma, Washington. Purcell is also a Registered Investment Advisor, and offers a flexible back-office trading platform for small Investment Advisors nationwide. Scott currently manages over $40 million of client money through these and other trading platforms.
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The Asset Enhancement Strategy
The Asset Enhancement Program has historically provided a high degree of capital preservation, while also producing a superior rate of return. The first thing Scott will tell you about his investment strategy is that its primary goal is capital preservation, with growth as the secondary objective. He says this is an important distinction that clients need to know up-front.
Scott defines his strategy as 90% mechanical and 10% discretionary. His methodology is a long-or-cash system based on technical analysis that attempts to discover the relationship between financial data and market performance. Overall, he says the methodology is a trend-following system using technical indicators. An excerpt of Scott’s own description of his trading strategy is as follows:
“Our principal objective is to minimize risk while maximizing returns. We obtain these objectives by monitoring market activity several times daily while applying our proprietary technical strategies. Research studies have shown that market events are not random and that discoverable relationships exist between different data and the performance of the financial markets. These research studies have assisted in the formulation of our technical strategies.”
Scott credits his real estate experience as being part of the reason he has been successful in money management. Real estate taught him that there are regular cycles in the market, and that these cycles can be predicted if you analyze the right market indicators. He leveraged these observations by incorporating them into a money management system that has shown a high degree of success over the last 10 years.
While the Asset Enhancement methodology was originally designed to pick up shorter-term trends, it has since been modified to look for intermediate-term trends of one to three weeks. Changes to the methodology became necessary due to the ever-increasing restrictions and short-term redemption fees being imposed by mutual funds.
Once his proprietary system gives a trading signal, Scott then selects the mutual funds in which to invest. He looks for low-volatility funds and will use anything from actively managed funds to low-cost index funds. He uses mutual funds representing all types of fund classes including domestic stock, international stock, bond, index, and even load funds from fund families who will waive the front-end loads for Investment Advisors. Scott will generally have one or two long positions per trade signal, but it can be more.
He does not “short” the market in this program. Instead, in declining markets he seeks the safety of bond funds or money market funds (cash). He estimates that on average the program is in stock and/or bond funds about 60% of the time, and in money market funds the remaining 40%. He has no profit stops in his system, so he will ride a winning trade as long as his system indicates it has potential for further gain.
The Asset Enhancement methodology does not employ any formal stop-loss techniques, but Scott does watch each trade very carefully, and will exit the market quickly when his system indicates the potential for losses is likely.
Scott has 90% of his own net worth invested in this program, so he says that he feels the same pain that clients do when losses occur. He candidly states that the only time he has done poorly in the market is when he allowed someone other than himself to manage his money.
The Asset Enhancement Program has an enviable track record that stretches back over 10 years. Since its inception in January of 1995, this strategy has proven its ability to both preserve capital and provide significant growth by posting an average annualized return of over 15% with a worst-ever drawdown of –13.31%, net of all fees and expenses. (See important disclosures at the end of this E-Letter.)
While Scott’s drawdown during the recent bear market was only –0.99%, his worst-ever drawdown (-13.31%) occurred from August of 1998 through March of 1999. He explains that a large portion of this drawdown occurred because the annuity product he was utilizing changed their trading policy and suddenly decided they would no longer accept trades or allow him to actively manage the account. Unfortunately, they also froze him in a trade that he could not exit until the annuity policy had actually been transferred to another carrier. Even though his system gave a sell signal that would have limited the loss, he was prohibited from acting upon it.
Scott clearly states that part of the loss would have occurred anyway because his system isn’t perfect. That may be true, but the Asset Enhancement Program’s performance during the recent bear market in stocks is nothing short of amazing. As I discussed above, during the 5-year period stretching from January 1, 2000 through December 31, 2004, the worst drawdown experienced by Scott’s strategy was a mere –0.99%. Compare that to the –44.71% drawdown in the S&P 500 Index or the –70% drawdown in the NASDAQ Composite Index, and you will gain an immediate appreciation of Scott’s potential to preserve capital.
Of course, downside protection is only half of the story. After all, a bank certificate of deposit can protect from losses, but at the cost of low returns. Scott’s program avoided major losses while also posting superior returns during the bear market of 2000 – 2002, the market rally in 2003, and the sideways market of 2004. Total cumulative returns for the Asset Enhancement Program were 109.10% between January 1, 2000 and December 31, 2004, equal to an average annualized return of 15.89%, net of all fees and expenses. Over the same time period, the S&P 500 and NASDAQ Indexes posted NEGATIVE average annualized returns of –2.29% and –11.77%, respectively.
See the actual performance history in the tables below for more comparisons and detailed monthly returns.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Please see important notes at the end of this E-Letter.
When reviewing Scott’s long-term performance, you will note that it shows only quarterly results during the early years of the program’s track record. This is due to the fact that this strategy was originally developed to actively manage variable annuity sub-accounts, many of which only provide quarterly account statements. In 2001, Scott adapted his trading strategy to allow for active management of mutual funds.
The Trading Platform
As noted above, Scott is essentially a one-man shop, and like many other individual money managers, he has outsourced the administrative tasks to a third party, namely Purcell Advisory Services. They provide back-office support for his trading activities and customer account administration, thereby allowing him to concentrate on market analysis and the generation of a trading signal.
Purcell is highly experienced when it comes to providing back-office operations for professional money managers, and currently does so for a number of Investment Advisors nationwide. Scott’s function is to provide trading instructions to Purcell on a daily basis, and in turn Purcell handles the account set-up paperwork, reporting, fee billing and other necessary back-office operations.
Because of this outsourcing, the ProFutures due diligence team also made an on-site visit to Purcell Advisory Services to review their administrative capabilities and internal controls. We are happy to report that they passed our due diligence review with flying colors.
The minimum investment for the Asset Enhancement Program is $50,000, and the annual fees are 2.5% billed quarterly in advance. Client funds are held in individual accounts at Trust Company of America (TCA), and clients have online access to their accounts via the TCA website. Both TCA and Purcell Advisory Services issue quarterly statements, and TCA produces year-end tax reports. Purcell also suppresses the generation of trade confirmations, thus reducing the amount of mail you receive on your account.
An important question that should be posed to any professional money manager is one of backup, should he or she become incapacitated. The fact that a manager’s trading model is proprietary sometimes makes finding the right individual for backup difficult. Fortunately, Scott’s affiliation with money manager Herb Friedman has continued. In fact, the two men talk almost on a daily basis, and are very familiar with each other’s trading systems. As a result, they serve as backup for each other’s investment programs.
"If you're not a risk taker, you should get the hell out of business."
Ray Kroc, Founder of McDonald's
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Very few money managers performed as well during the last five years as Scott Daly has. Not only did he dodge significant drawdowns during the bear market, but he also posted an impressive return that easily outpaced the S&P 500 Index.
In light of Scott’s historical ability to preserve capital in a bear market as well as produce consistent returns, we feel that the Asset Enhancement Program would be suitable for investors who are looking for professional money management that offers participation in the equity markets with reduced risk and capital preservation. Specifically, this program may be especially suitable for those who have recently received a lump-sum distribution from their retirement plan, sold a business, or who have come into an inheritance.
In addition, the Asset Enhancement Program may also be a very useful diversification tool for virtually any investor who wants to include a less volatile investment in their portfolio without giving up too much in the way of potential returns. Investors with existing variable annuity contracts should also explore how the Asset Enhancement Program might be able to be used to actively manage their annuity sub-accounts.
If you have questions or would like to talk to one of our experienced Investor Representatives about how the Asset Enhancement Program may fit in your portfolio, please give us a call at 1-800-348-3601, or e-mail us at firstname.lastname@example.org.
To view information on all of the money managers we recommend, go to our website.
Very best regards,
Gary D. Halbert
"Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend any product or service advertised herein, unless otherwise specifically noted."
Forecasts & Trends is published by ProFutures, Inc., and Gary D. Halbert is the editor of this publication. Information contained herein is taken from sources believed to be reliable, but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgment of Gary D. Halbert and may change at any time without written notice, and ProFutures assumes no duty to update you regarding any changes. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Any references to products offered by Halbert Wealth Management are not a solicitation for any investment. Such offer or solicitation can only be made by way of Halbert Wealth Management’s Form ADV Part II, complete disclosures regarding the product and otherwise in accordance with applicable securities laws. Readers are urged to check with their investment counselors and review all disclosures before making a decision to invest. This electronic newsletter does not constitute an offer of sales of any securities. Gary D. Halbert, ProFutures, Inc. and all affiliated companies, InvestorsInsight, their officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Securities trading is speculative and involves the potential loss of investment. Past results are not necessarily indicative of future results.
04-05-2005 11:48 PM
Gary D. Halbert