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.
Michael J. Chapman, CFP®, CIO
Adopting Tactical and Absolute Return Strategies, which use risk management can, under the right circumstances, out perform and potentially reduce losses more than traditional buy and hold / benchmark strategies during weak cycles.
The past 200 years of stock market history show that weak performance periods follow strong periods. We may be witnessing the completion of a strong cycle here in fall of 2020.
Time Period Annual Average Return Duration
1815-1835 10.0% 20 Years
1843-1853 13.7% 10 Years
1861-1881 12.0% 20 Years
1987-1902 15.2% 5 Years
1921-1929 25.2% 8 Years
1949-1966 14.0% 17 Years
1982-1999 14.9% 17 Years
2009 - 2020 16.1% 11 Years
Average 14.8% 13.5Years
Weak periods have lasted up to 20 years
Time Period Annual Average Return Duration
1802-1815 +2.7% 13 Years
1835-1843 -0.6% 8 Years
1853-1861 -3.0% 8 Years
1981-1897 +3.9% 16 Years
1902-1921 0.0% 19 Years
1929-1949 +0.8% 20 Years
1966-1982 -1.4% 16 Years
1999- 2009 -8.4% 9 Years
Average -0.75% 15.1 Years
We are 11 years into a strong cycle, Valuations are stretched to levels not seen since 1999, the end of the dot com period. Now would be a good time to consider adding a absolute return and or tactical approach to your investment portfolio.
Past performance does not guarantee future returns. The success or failure of a tactical and absolute return strategy depends upon many factors including but not limited to the managers's ability to avoid large market losses. There can be no guarantee that PCM will be able to avoid such losses or that PCM will be able to identify periods of week performance in the stock market in the future.
Weak and Strong Market Cycles is research by Robert Powers and Sy Harding Market Cycles Study. The Table above summarized Powers' interpretations of strong and weak cycles, along with average annual returns adjusted for inflation and duration of the cycle
Provident Capital Management's belief is that superior full-market cycle returns are directly correlated to a reduction or elimination of large drawdowns in any given portfolio or investment strategy. To accomplish this, an investment strategy must employ some form of risk management and should have the ability to capture positive returns in both rising and falling markets. Furthermore, it is important to have the ability to participate in all asset classes, all asset sizes and all asset styles across all markets to insure diversification that is truly non-correlated.
Our firm uses ETF's and stocks to bring to market model driven, quantitative, multi-directional strategies, formerly only available to institutions and accredited investors. These strategies are available in liquid and transparent separate managed accounts offering investors an attractive alternative to the traditional mutual and hedge funds.
Provident Capital Management is committed to providing the investment community with high-quality absolute return and tactical solutions that are liquid and transparent. We offer an attractive alternative to hedge funds, mutual funds and traditional buy and hold strategies.
Tools and research are available to develop strategies that will deliver respectable performance in today's low return environment. Wall Street's preference for "benchmarking" equity managers to traditional equity indexes exposes institutional investors to excessive risk as measured by draw-downs (up to 30% to 50% over the past 5 and 10 years). Furthermore, recent high correlation across all asset classes, especially in times of financial distress, is minimizing benefits of traditional asset allocation.
Provident offers a solution to the dilemma of portfolio shocks and high volatility, large and prolonged draw-downs and cyclical low returns. Provident's strategies can be used in conjunction with traditional asset allocation approaches or used as a distinctive investment methodology. Through its multi-factor quantitative approach Provident's strategies have been built for the present and future. Portfolios and strategies are designed to produce positive returns in up, down and sideways markets.
Through risk mitigation, without sacrificing upside capture, PCM's quantitative strategies reduce portfolio draw-down and enhance returns. Our service is delivered via liquid and transparent separate accounts or LP structure through major custodians such as TD Ameritrade and Schwab. We measure our success by how effective we are at producing positive returns with as little volatility as possible versus comparing our performance to an arbitrary index.
What are Absolute Return Strategies?
"Absolute return funds look to make positive returns whether the overall market is up or down, while index-tracking funds try to beat the index they are tracking." - Forbes, Investopedia
PCM's Absolute Return Strategies use low-volatility investments such as cash and money market funds, and then at times selected by the manager, will take directional positions in index Exchange Traded Funds. The strategies historically offer low correlation to financial market performance such as the Standard and Poors 500 Stock Index (S&P 500 Index).
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