The second quarter experienced a sharp rise in interest rates marking the beginning of the end of the easy money policy known as Quantitative Easing (QE). Yields on the Ten Year US Treasury rose from 1.6% to 2.6% in a month and the S&P 500 index pulled back nearly 6%. Over the last 140 years, yields on the Ten Year US Treasury have averaged 4.67%. This recent rise in yields from 1.6% to 2.6% is the first move of several over the coming years as rates begin to normalize. This Federal Reserve’s easy money policies have helped the economy and the housing market to rebound; however, the Federal Reserve cannot continue buying bonds at a rate of nearly one trillion dollars a year without consequence.
The return to normal rates should occur over the next three to five years and will likely cause market volatility like that which occurred in May and June. With a stabilizing economy, equities should continue to rally on improving earnings, but this recovery is different than normal cyclical recoveries. The weak nature of this recovery leaves this economy vulnerable to a new recession from many risks like rising rates or international economic weakness. The market appears most concerned with the adroitness of the Federal Reserve’s planned “taper” of US Treasury and mortgage purchases from $85 billion a month to zero in the year or years ahead.
Master Limited Partnerships (MLPs) have had a very strong year and our performance in this asset class continues to be excellent. Last year MLPs underperformed the S&P 500 due to tax selling at year end as investors sold their MLPs before tax rates went up with the New Year. Our asset class performance, this year through June 30th, is up 21.73% before fees and is in line with the MLP Indexes. For the last 12.5 years our performance is up 22.25% annualized and has outperformed the Alerian Capitalization Weighted Index by 3.39% annually. MLPs offer attractive tax advantaged income, growing distributions and stable toll road business models based on the transportation of petroleum distillates and natural gas. With the shale energy boom, MLPs should see significant capital expenditures over the next two decades which should help to fuel further growth in this sector.
To improve our investment results, we have increasingly been using quantitative analysis for stock selection and market timing. With the proliferation of investment data and sophisticated analytical software, the investment business is increasingly embracing quantitative analysis and strategies. We believe that those who use them will outperform in the future. One ally in this effort is Charles Zhang who is now working with us. He is a former intern, Columbia University graduate with 800s on his SATs, and has worked in trading, research, and quantitative roles at three pedigreed New York investment firms.
We offer several quantitative strategies in addition to our income strategies. If our back tested returns come anywhere close to our future returns we believe you will be very happy with our new portfolio strategy options. One new strategy is our Graham and Dodd Net Net Plus strategy.
Benjamin Graham’s principal investment strategy was to buy companies below their liquidation value. Compared to book value, the liquidation value is a more rigorous standard. It excludes many items such intangibles and properties/equipment that are difficult to ascertain value. This strategy is an improved version of the time tested buying below liquidation value strategy. It looks for stocks that are selling close to their liquidation value because, in today’s market, there are currently no stocks selling below liquidation values. It looks for additional safety by avoiding stocks with low quality assets and stocks with potential to be fraud.
The strategy has impressive back tested results over the last 14 years (1/1/1999-7/12/2013) – our 10 stocks Graham and Dodd Net Net Plus strategy has a 32.0% annual total return, before management fees, versus 2.2% for the S&P 500. The exceptional outperformance comes from the effectiveness of the strategy’s stock selection and our value added risk management overlay. The risk management overlay avoids stocks with less than $100 million market cap, enforces a 25% entry based stop loss rule, and it utilizes macroeconomic and market risk indicators to signal when we should take less risk.
Being a boutique investment firm aids us in our quantitative efforts because the pricing anomalies which we identify cannot be taken advantage of by large institutions due to liquidity constraints. As such, we believe our quantitative strategies should provide our clients with real opportunities for superior performance and outperformance that will not be matched by larger institutions.
Please contact us to learn more about our quantitative and income strategies and how they can benefit you.
Sincerely,
Tyson Halsey, CFA
Managing Member
|
Models represent hypothetical or simulated performance, not actual trading. Since the trades have not actually been executed, the results may have under-or-over compensated for the impact of certain market factors, such as liquidity. Our simulated returns include dividends, commission and slippage for each trade. Remember that past returns are no guarantee of future returns.
|