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AI Portfolio Performance
Like the Hedge Fund Research Global Hedge Fund Index (HFRX), AI's secondary objective is to provide an absolute return (consistently positive returns). Neither hedge funds nor the AI 75-50 Portfolio have done so since the S&P 500's peak in October 2007. AI 75-50 has outperformed its benchmark, HFRX and the S&P 500 (Figure 14). AI 75-50's primary objective is to capture 75% of the S&P's upside and 50% of its downside, which requires us to hedge S&P beta nimbly while maintaining core Beta (equity and bond exposures). The portfolio's 11.1 annualized standard deviation (ASD) is higher than that of HFRX, but much lower than that of the S&P since the market's peak.
Upside & Downside Risk
Our estimation is that there is significantly more risk from being too short (low Beta exposures), which reduces future returns. The market is extremely oversold after being down about 60% since its prior peak. Oversold Panics, even those that lead to depressions, experienced 30% to 90% countertrend rallies while remaining in a bear market.
Even if we are wrong in hindsight for enhancing Beta exposures now, AI 75-50 should still best the S&P 500 if the S&P's 660 price support fails and stocks trade down from here. If so, the market should give us an opportunity to reduce Beta and reestablish defense as we did in December 2008 when we added EEV, SCC and SMN. We also added QID in early February 2009, and then sold all 2x inverse ETFs except for EEV, which we are attempting to sell at $80.
The PowerShares DB Crude Double Long ETN (DXO) was also added in late February as a proxy for Energy sector beta. Crude will turn up in anticipation of economic recovery. DXO is no enterprise risk. We will sell DXO at $3 and then employ the proceeds to buy Energy sector shares. Our time horizon for this trade is 12 months, or as soon as it hits $3, which should be met if crude prices rise to $50 per barrel.
All positions and our strategy view for each holding are listed in Figure 15 along with our Beta-Non Beta allocations and themes (see Defend to Advance: Minsky Moments ). Our strategy objective has been to reduce gross exposures and to increase net long exposures over the past three weeks as the S&P 500 nears a 62% retracement of its entire gain from August 1982 through October 2007. If this level is breached, the next major price support level is in the 450-500 range, which sets up beta assets for significantly more downside risk in spite of the market's oversold condition.
Month to date (MTD) as of March 6, 2009, we are down 2.5% while also down 1.5% year to date (YTD). Our strategy is also more dependent upon hedging inflation over deflation risks, which has caused us to be down since our 4% gain in January 2009. Deflation concerns have dominated since the market broke its November 2008 lows late in February 2009.
Endnotes
- Giles Keating & Stefano Natella, Credit Suisse Global Investment Yearbook, February 2009, page 6.
- Mohamed A. El-Erian, CEO of Pimco, and author of "When Markets Collide: Investment Strategies for the Age of Global Economic Change," a timely alert to the fundamental changes taking place in today's global economic and financial systems.
- John Serrapere, Driving Mr. Market, Fundamentals Lead, Meet Mr. Credible, Active Indexer, March 18, 2008
John Serrapere is the investment analyst and portfolio strategist for Foster Holdings Inc. in Pittsburgh. He also works on research and consulting projects through Arrow Insights.
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