Investing or not?

An individual should always be invested in stocks. Stocks are the asset class that
delivers the most returns over the long term. For a person to build wealth, their
capital should be allocated to the stock market in order to take advantage of
compounding.

Stocks have returned for the past 200 years an average annual return of 11% a
year, which translates a growth of 7-8% a year on real returns.

At this rate 1 dollar in 1800 would now be worth 11.6 Billion dollars.

From more recently 1 dollar invested in 1980 would now be worth $46, so one
should take notice on the importance of stocks in investing.

For the average investor, a simple buy and hold approach with a dollar cost
averaging strategy will result in superior returns.

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What if an individual wants to be more active in their investments?

In our opinion, an investor should only invest while there is a Bull market in place,
and then switch to T-Bills short term once a bear market is installed. So a person
should invest in the direction of the trend. Just as much a person should not swim
against rip tides, one should not go against the market.

Therefore, One should only invest if the direction of the market trend is up.

If indeed a bull market is forming, there is no need to buy right at the bottom. Once
there is evidence the trend has changed, there is still lots of money to be made.

When you drop a knife do you try to grab it while in the air? Why not? The same
goes for a stock on a downward trend.

The real outstanding returns are made from being on the side of large movements
in price (trends) not by trying to pick bottoms and tops which is a futile exercise.

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Here, we have the FTSE under a trend timing approach.

Note that the returns for the past 10 years on buy and hold were of -11%. Note how
under this approach an individual was able to catch the bull markets and profit from
a rising economy, while at the same time avoiding the bear markets or even profiting
from them, depending on the profile of an investor.

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Here the philosophy of the concept remains the same, although in a much simpler
manner and yet just as efficient.

A simple moving average was used on a monthly chart.

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In this slide, we have the historic results of the performance of the market versus
the performance of going in the direction of the trend applied to the S&P500 for the
past 108 years.

See how all the measures of performance increased with the timing strategy.
Especially the maximum drawdown, which the most an investor saw his account
falling before a new high is made.

Also, in the 10 worst years for the market as a whole the timing strategy was able to
avoid the negative movements for all situations but one, in 1973 which were very
close to each other.

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Here we have just an equity chart of the performance of both strategies. The big
decline on the blue equity line is the 1930’s Great Depression. At the top, we have
small blips to the downside that correspond to both the dot.com bubble and the
2008 Crash.

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Benefits of following the market are:
There is no bullish or bearish biases, as Jesse Livermore once said “There is no bullish side or bearish side, only the right
side”,
It requires no discretion at all, meaning an investor would simply follow hard based rules regardless of what the market is
doing, or what the investor may think the market will do.
Trends exist everywhere, always coming and always going. Whether fashion, business or whatever, we all want to find
trends and ride them as far as they can go. Markets are no different: they trend up and down too. That said, no one can
predict a market trend, you can only react to them! Trend following never anticipates the beginning or end of a trend. It only
acts when the trend changes! Usually trends go way beyond than anyone expects, so anticipating anything is a futile
exercise. There is no need to try to understand “why” a market is trending – we just have to follow it. We don’t need to
understand electricity in order to use it.
In this slide, we constituted a portfolio both for buy and hold and for the timing strategy.
The portfolio would be constituted by 5 assets: S&P500 mirroring the stock market behaviour, the Goldman Sachs
Commodity Index mirroring commodities, the Government 10 Year bonds, NAREIT which mirrors the real estate market and
MSCI EAFE, which mirrors the global equity markets apart from USA.
This assures that one would be diversified on different asset classes, and the first change we notice is first and foremost the
benefits of diversification by a significant decrease in volatility, maximum drawdown and the worst year return of the portfolio
compared to the same metrics on each individual asset. This is explained due to the fact that at a time that one asset class is
not performing, others will, dampening the negative effects of the underperformer asset
Applying the diversification to the timing strategy, it retrieves bond-like volatility with stock type returns.
As we can see with the table, the returns are 15% higher than the market, while the volatility is 30% lower. A very significant
change is on the maximum drawdown with a 36% equity loss on buy and hold versus a 9.5% equity loss with the timing
strategy

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Here we have the performance of the portfolio of the previous slide, put into a graph
and on a linear scale in order to give a better perception of volatility.

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Since the original timing strategy had bond-like volatility an individual could choose to leverage it’s investment.
This leveraged portfolio still maintains to achieve lower volatility than the stock market, and squeeze out extra returns due to
the fact of being leveraged. Also in our opinion both volatility and Sharpe ratio unfairly penalyze this type of strategy, making
it look “riskier” than it’s true risk. Volatility or standard deviation as we know it, does not care whether volatility is on the plus
or the minus side.
Nicola Meaden, a researcher, compared montlhy standard deviations and semi-standard deviations (volatility measured on
the downside only) of funds applying these type of strategies and found that although this type of strategy arguably
experiences higher volatility, it is concentrated on the upside, not to the downside. This happens because one of the motto’s
of the strategy is to cut the losses the fastest possible, and let the winning positions ride.
The same is true for the Sharpe rattio since it’s derived from the “normal standard-deviation” and not from semi-standard
deviation it will also affect the final result. On his study, Meaden found a different story. Risk or volatility measured from
normal standard deviation was of 12.51%, while measuring only to the downside,strategies of following trends their volatility
decreased to 5.79%. This means that most of the volatility is concentrated on the upside, which is a good thing since in order
to profit we need the markets to move.
For that, in this case we consider the maximum drawdown to paint a much cleanier picture. While the leveraged portfolio has
more “normal” volatility than buy and hold portfolio, the maximum dradown was 42% lower, which to the normal investor is a
much more important metric. Afterall what’s better to see in your account balance? A loss of 36% or a loss of 22% ? This
means that if we could tolerate a maximum drawdown of 35% for example which is still under that of the market, one could
increase the returns by almost 40% to an annual return of around 22% year.
Also You may notice that the portfolio of the 2X Timing, its returns are not twice the size of the original. That is, because one
needs to pay interest when leveraged, so instead of getting a return of 22.54% a year, the 15.27% is a result of paying the
interest of the risk-free rate pluis a premium.
Still, one could see the superior returns achieved with such a strategy with a volatility lower than of the market.

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So as conclusion, we saw that an individual should always seek investing in order to
obtain the market returns. If an investor would like to achieve superior returns, a
more active management is needed. Therefore we saw the benefits of investing
with the trend. The trend as we saw in a previous slide for the FTSE has been up,
therefore we should allocate our capital into the market.

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Index derived from the average of all managers that invest with the trend on their
side.

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Index derived from the average of all managers that invest with the trend on their
side versus Worldwide index markets

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Index derived from the average of all managers that invest with the trend on their
side.

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Some performances from trend following funds.

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