January 8, 2010
4th Quarter Commentary
INVESTING PROACTIVELY WITHOUT PREDICTIONS
“If you’re going to predict,” an anonymous economist famously quipped, “predict often.”
2009 by all accounts was a good year. The S&P500 gained 23.4%. Emerging markets, which at the end of 2008 had been labeled “submerging markets”, were up 75%. Who could’ve predicted it?
From its lowest point in early March, the value of U.S. stocks increased $5.6 trillion to $13.4 trillion, representing a boost in investor net worth of 71%. And yet, investors pulled $7.67 billion out of stock mutual funds, proving once again that timing the market can be futile, not to mention costly.
This is why we don’t rely on predictions.
Undoubtedly this explains the almost universal question on every investor’s mind these days: when will the other shoe drop? The correct answer is notoriously hard to pin down. But, it is far better to be proactive than reactive. Partnervest is being proactive in several ways. First, we do not take 2009’s rally for granted, and we are employing strategies to help protect the gain we’ve made thus far. Second, we continue to expand our STAR™ strategies to benefit from both positive and negative price swings.
Much of the press has been calling the last 10 years a “lost decade” for investors. But was it, really? As the chart below illustrates, the S&P 500 declined 9.10% from December 31, 1999 through the end of this year, just under 1% on average per year. However, the performance of other investments was positive; including U.S. Treasury 10 year bonds, up 90.60% and gold, which appreciated over $800/ ounce or 280%. The price of a barrel of oil increased 210%, from $25 to $80. Furthermore, investors had access to foreign equity markets, including emerging markets, which gained 155%. Taken collectively, all five indices (including the S&P 500) finished the decade up 143%.
Economics is often referred to as the “dismal science,” for good reason. Reading the current economic tea leaves gives a mixed picture at best. In fact, the market seems to have become schizophrenic, initially rising in spite of a gloomy economic forecast, and then continuing to advance in tandem with classic safe haven investments such as gold. Throughout 2009 both stocks and gold made significant advances, defying conventional wisdom.
Review and Preview
The New Year is a good time for a little introspection, a chance to be honest with ourselves with the intent of doing better in the year to come. In this spirit we present the following:
The year that was
At the end of 2008 valuations were compelling and volatility was sky-high. Partnervest took the opportunity to add allocations to some of the worst-hit markets: Emerging Markets, REITS and Preferred stocks. We are always students of the market – a difficult task at times since the rules can change without notice! We constantly assess the current economic climate and we kept our allocation to global bonds and foreign stocks, which fared better than their U.S. counterparts due to the decline in the U.S. dollar.
In STAR III, VEGA™, Partnervest took full advantage of the historically high volatility to capture a high level of option income. As markets across the globe began their spectacular 9 month advance off the lows, volatility dropped to average levels, but we were able to keep pace with the rally by continually targeting ever higher levels on the Exchange Traded Funds (ETFs) that comprise the investment portfolio. In our Alpha strategy, we added Gold to the portfolio alongside the S&P 500, and thus were able to benefit from the positive price appreciation from both. Finally, we launched the Treasury Overwriting Strategy, which invests in the U.S Treasury ETF and adds an additional layer of income in the form of call premium. In this manner, the current 4.50 % yield is augmented by an additional 8-12% return from covered calls.
The year to follow
STAR™ II It is a sound investment strategy to sell a portion of one’s more volatile investments after a significant rally, in order to lock-in the gains and have equity available to repurchase them after a decline. In STAR II Partnervest manages this two ways; first, by opportunistically rebalancing when the performance spread is high, and second, by allocating a certain percentage to “alternative asset” strategies that have downside buffers built in. Most recently, we’ve added the Goldman Sachs Absolute Return Tracker (symbol: GARTX) fund to the alternative asset allocation. As a prime broker, Goldman is privy to the holdings of over 1,800 diverse hedge funds, and has done a good job replicating those holdings with this fund. The net result is access to the collective wisdom of a large number of hedge fund managers – without the corresponding high fees. GARTX charges less than 1% per annum, compared to an average 2% of assets and 20% of performance levied by hedge fund managers.
STAR™ III
VEGA’s structure has a built in “buy low/ sell high” methodology; systematically selling the more volatile ETFs when performance is positive, and repurchasing them when they decline. Furthermore, during and immediately following any sell-off, volatility spikes, resulting in a higher percentage contribution from the option income the strategy harnesses. Going forward, we are expanding the scope of VEGA to include additional enhancements for accumulated premium income as well as a proposed launch of “Tactical VEGA” which will incorporate Partnervest’s proprietary market climate indicator, dubbed PULSAR, into the strategy logic.
Alpha is more “volatility neutral” in that the strategy affords downside protection up front. However, Alpha can potentially benefit from a stock market drop in several other ways. One, bonds historically rise when stocks fall. Interestingly, this has proven true regardless of the level of long-term interest rates. Two, the factors that influence the price of both bonds and gold are independent, and in some cases opposite, those that affect equities. In this context, we are considering adding oil to the model, which will have the effect of further reducing correlations and increasing the consistency of returns.
In summary, Perhaps Yogi Berra said it best; “It’s tough to make predictions, especially about the future.” Markets will rise and fall, but thankfully, we need only make one prediction for the coming year; that they will invariably do both.
Sincerely,
James Herrell, CFA
This client letter is published by Partnervest Advisory Services LLC and is provided free of charge. Any stated or implied recommendations herein are of a general nature and clients should consult with their Partnervest representative for advice concerning their particular situation. Information from third party sources is deemed but not guaranteed to be reliable. Due to varying needs and circumstances, allocations and performance of individual accounts may differ from their corresponding STAR model. Past performance is not indicative of future returns. Indices do not reflect actual portfolios or trading and the stated returns do not include investment management fees, transaction fees, dividends and other earnings and the timing of investment decisions, thus, they are not necessarily indicative of the allocation or returns that an actual managed account in the future will or would have achieved. Investment advisory services provided through Partnervest Advisory Services LLC.
(c) Partnervest Advisory Services LLC
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