Michael J. Chapman, CFP^®, CIO

Investing with an absolute approach is different from buying and holding. Typically, it involves buying and selling investable instruments with a goal of positive returns every year, regardless of how a relative benchmark is performing. Our absolute investing philosophy centers around this concept and our mission is to bring viable strategies and options that seek absolute returns to the individual investor.

At the center of our absolute investment approach is risk management. As market participants, we can not influence the returns any given investment will provide, that would require a crystal ball, but we can actively manage the risk our portfolios are subjected to.

Our risk management begins at the strategy level and then rolls up to the entire portfolio. Our first objective is to use various strategies, whether created by Provident or other money managers, that tend to offer low correlation to one another. Typically, risk managed at the strategy level may incorporate various options, such as using stop-loss orders, purchasing puts, diversification through the holdings within a strategy and the ability to move to cash.

Managing risk and having an absolute return approach don't guarantee portfolios will be positive every year, but it offers a little more peace of mind when you commit hard-earned capital towards achieving an investment goal.  See related articles on drawdown and the mathematics of winning and losing for additional information on the benefits of risk management.

Diversification goes beyond the traditional asset allocation models proposed by many financial professionals.  In reality, traditional asset allocation models that focus on dividing a portfolio among growth, value, international, small-cap and large-cap stocks may be subject to more risk than one realizes.  The following represents the correlation of stock categories for a traditional diversification approach found in table 1.0 versus the correlation of various Provident Capital Management strategies in table 1.1.

Ideally, one seeking diversification would want to find investment options that are not correlated to one another, meaning the strategies' respective performance moves independently of one another.  Typically, the closer the correlation is to zero, the lower the volatility of the portfolio will be, leading to potentially a lower drawdown and a higher risk/reward scenario.

Investment options that are closely correlated (i.e. close to +1) will be found to move in the same direction, minimizing any attempt to achieve diversification.  The inverse is also true, investment options that are negatively correlated demonstrate a connection by typically moving in opposite directions.