The Model Program

 
Over the past 25 years, we have worked to identify relationships between market and economic data and the performance of financial markets in an effort to reduce volatility. The Model Program is a powerful tool which provides us with unique research that uses sophisticated computer algorithms and on-line databases. The system is designed to analyze the financial markets and develop complex active allocation models in an effort to reduce volatility and provide competitive returns. As the economy experiences cycles in various sectors, the financial markets often respond to those cyclical movements. These cycles create identifiable trends that provide systematic “buy” and “sell” signals as the market changes.
 
We combine our own technical analysis with The Model Program to offer an unemotional alternative to traditional management methods. With that strategy in mind, we have developed multiple investment models that seek above-average returns focusing on the risk/reward relationship. These dynamic risk management techniques provide us with a system to potentially maximize the performance and maintain assets within a defined investment complex.

A defined investment complex can be comprised of mutual funds, variable annuity and variable life sub-accounts, 401(k) groupings or any other platform that offers well diversified grouping of investments. The key to investment modeling is focusing on potential risk, volatility and being informed on how all the investments in the group are currently performing. Just as the economy experiences cycles, so do the financial markets. There are times to own bonds, stocks and commodities and more importantly there are times to sell them. Using this sophisticated computer technology coupled with market and economic data, we can more successfully monitor market trends to detect periods of sustained up or down movements.

Not every investment decision will be profitable. During periods of "trend-less" market behavior, the models can and will have a difficult time identifying the best investment sector. However, the allocations often employed by us involves focus on asset diversification that may help buffer a "trend-less" market much like traditional asset allocation programs, thereby, allowing for the next "trending" market to be identified and allocated appropriately.

The Model Program provides investors the comfort of knowing that their investment assets are invested in a defined mathematical program that screens for what are believed to be superior-performing securities.

How a Model is Created

The initial screen: Fundamental Analysis
  • Multiple broad searches are conducted to narrow the potential candidates.
  • Mutual funds meet a 5 year track record history to enter as a potential candidate.
  • Focus on mutual fund managers that consistently perform with high alpha rankings.
  • Beta, Performance History, Basic Risk Rankings and Market Capitalization is evaluated.
The risk assessment: Risk Analysis
  • Multiple objectives of Conservative, Core, Moderate, and Growth are used as labels for the models.
  • Once objective is selected, we filter investments according to volatility and potential drawdown.
  • Volatility of mutual funds over 5 year cycles are studied.
  • Correlation studies to indexes and benchmarks are performed for final determination.
Macro universe identification: Investment Grouping
  • Mutual funds that pass the first two steps are further limited by expense features.
  • In-depth reviews of mutual fund policies and trade limitations are studied.
  • Fundamental characteristics with indexes and peer groups are compared.
  • Select list of mutual funds provide diversification by asset class and style.
Selective Grouping: Technical Analysis
  • Grouping based on objective is created. (e.g. Conservative, Core, Moderate, Growth)
  • Groups are organized based on results from fundamental analysis.
  • A review of investment overlap is performed to check diversity.
  • Begin computer testing to validate performance across many market cycles.
Computerized Testing:  Model Calibration
  • Computer based testing helps test the robust nature of the mutual funds.
  • The computer selects a minimum holding period for the model.
  • When computer testing passes specified criteria the model is released to software inventory for consideration.
 
How a Model Makes a Selection
 
How a Portfolio is Constructed
 
Platform Selection
 
Asset Identification: Where are the assets currently held? One of the strongest attributes of this program is how the technology works with many different investment platforms. This allows us to be flexible in the decision of what platforms to use for various clients. Additionally, it reduces the need to transfer assets from one platform to another. This helps to activate management quickly and efficiently, while reducing or eliminating transfer costs. However, while our technology is flexible to accommodate many platforms, some mutual funds have restrictions that can limit the amount of models to be used on their platform. Therefore, in circumstances where a platform contains trade limitations or other restrictions we can make an informed decision as to how to make the best use of the Model Technology.
 
Start with an Objective
 
Initial search: Advisors often have a preconceived objective for a desired risk/reward portfolio. Experience has shown that the best portfolios are typically composed of 9 to 13 models. Why 9 to 13? What's significant about that range of models in a portfolio? We believe the market is efficient in its daily pricing of securities. We also believe that asset allocation plays an enormous role in both appreciation and depreciation of a portfolio due to general trends within various sectors of the market. Therefore, we subscribe to an active review of investment pricing, while diversifying the holdings of those mutual funds to multiple asset classes in amounts up to 9 to 13 positions per portfolio. We believe in order to achieve returns that are desired by most public customers, we need to have a certain level of concentration of asset classes. The intent of investment concentration is to allocate assets in positions showing current strength with the expectation of continuing appreciation while being invested in those positions. In moving to strength with concentrations of assets of 9 to 13 positions, we hope to out perform traditional asset allocation and other benchmarks or indexes that display similar risk characteristics. We have performed multiple studies internally that show evidence of using fewer than 9 models can create too much concentration into one or two sectors at any given time, thereby raising the risk of a portfolio; while having more than 13 models creates, in our opinion, unnecessary diversification that relegates a portfolio to perform in tune with broad market movements that may not bring any additional value to the portfolio management process.
 
Test Different Mixes of Model Risk Categories
 
Our Unique Selection Process: Upon identifying the platform and objective for a desired portfolio, we can search the available models and begin construction of the portfolio. The construction phase encompasses matching models of different characteristics (conservative, core, moderate, growth) and then testing those mixes with historical market data to evaluate the portfolio's ability to handle multiple market cycles. We also focus on investment overlap to help make sure that the portfolio maintains a level of diversification. Like traditional investing we do believe diversification is paramount to help defend a portfolio from too much concentration in one sector.

Portfolio Completion
 
Accepting the Portfolio: If a portfolio displays the characteristics that we deem appropriate, then we will save the portfolio and be able to run signals on that portfolio. A sample portfolio may have the following characteristics:

In this example, each model acts independently of the other, selecting one mutual fund at a time; rendering 12 individual positions that comprise the overall portfolio. Each position in a 12 model portfolio represents approximately 8 percent of the total value of the overall portfolio.

The following chart is an example of a 12 model portfolio that shows various asset classes that could be selected by The Model Program.
 

Investment Allocation Transition to Portfolio Positions
 
The decision to activate management: As discussed earlier, these models work independently of each other and have separate characteristics including minimum holding periods. The data provided by the models helps us make informed decisions concerning holding periods and asset allocation. When additional contributions are added to an account it presents the need for an immediate decision. Should we allocate the entire portion of available assets to the current or existing portfolio positions or should we wait for the next model signal to trade to get in sync with the model positions. (Example: Growth Model 1 has a 95 day minimum hold. We are currently 75 days into that minimum hold. Should we buy the current position knowing that a trade may happen in the next 20 days or should we wait in cash until the next trade signal that will start a new 95 day minimum hold? There is no assurance that Growth Model 1 will trade on the first day outside the holding period. Once a model is out side the minimum hold period it can sell at any time, but if the current position is still the strongest place to be, the position will be maintained until the model identifies a stronger place for which to allocate.)

The main premise we wish to convey is that The Model Program is a tool that we use in conjunction with our normal market analysis. We use our understanding of the signals provided by The Model Program and implementation of the investment research to make our final investment decisions and recommendations. This system is a process of long term investing with intermediate term evaluations that allow us to perform daily reviews of new market data.
 
 
Frequently Asked Questions
 
Why is there a mandatory holding period in a model and why are they different?
 
As the model calculates, it will arrive at a minimum hold period, which is unique to each model. This is the minimum number of days it will hold a fund before it can select another fund. The analysis in part, determines the minimum amount of time an investment in that fund should be held in order to have the greatest chance of showing a profit on that investment.
 
Minimum hold periods limit whipsaw trading, whereby a mutual fund shows positive performance and then encounters a short-term downward cycle. When an asset class experiences this type of price action, a mandatory holding period can prevent impulsive movements out of a signaled position, when a loss would be guaranteed. Our philosophy is to let the fund manager do what they do best, manage a single asset class. Weathering these short-term downside movements can provide increased profitability and eliminate unnecessary trading.
 
Minimum hold periods range from sixty to one hundred and thirty five days. Once the minimum hold period is met, the program reanalyzes the entire universe of funds daily, until another fund has a higher score, causing the model to recommend an exchange of the current fund into the new, higher ranked fund. A model may hold a position for an unlimited time period as long as it continues to have the highest score. However once a new fund is recommended, the minimum hold period must be satisfied before a new fund will be recommended.
 
How is The Model Program different from Time Zone Arbitrage or other short-term timing strategies?

Minimum hold periods of 60-135 days used by our models are not disruptive to underlying portfolios unlike the daily trading systems often used by short-term market timers. Time zone arbitrage strategies that try to capture gains based on closing prices from markets abroad are unfair. Robbing the mutual funds shareholders of profits they have earned. Our models do not have involvement in either of these unethical, if not illegal strategies. Due to the infrequent exchanges generated by our system, the heightened scrutiny surrounding abusive, short-term market timing and time zone arbitrage will have no impact on our models. Traditional market timing models are predictive in orientation, often overvaluing market stimulus while undervaluing market response. The models look only for the market's response as reflected in the share price of mutual funds. Our methodology seeks only to observe, not predict.


How is this different from portfolio optimization?

Portfolio optimization makes reference to asset allocation models, which are static in nature. These models often seek multi-year performance trends. While these traditional strategies are popular, in our opinion, static allocation models afford investors less protection in falling markets than that offered by The Model Program. Portfolio optimization strategies are not designed to respond to current market conditions; however they do provide a basic level of discipline and diversification. Since static models maintain a position in virtually all asset classes, they are exposed to asset classes with negative current performance and will remain in these underperforming areas. The Model Program’s strategies look to actively identify sectors of the market that are displaying current productivity and offer information that identifies market trends early enough to allow professional advisors to make informed decisions as to current and ongoing allocations for the portfolio. The continuous review of market pricing is what makes The Model Program reactive to trends which vary in range from 60 to 180 days. This style intends to participate in the appreciating sectors, as well as evacuate the sectors that are showing a lack of performance. To maximize the possibility of positive performance, our process will repeat evaluations of the market pricing in intervals of 60 to 180 days.
 
What asset classes do you consider?
Since every asset class has performance potential, all asset classes ranging from small cap international growth funds to US Government bond funds and sector funds may be found in a growth model's fund universe. This broad range of investment choices enables our models to capitalize on upward trends in the market, while having several defensive mutual funds to retreat to during a negative equity market environment. In the case of a moderate risk model the most aggressive fund may be a large cap growth fund, with all the other funds in the model's universe offering less risk. Large cap value, balanced funds, as well as all types of bond funds are also appropriate for the fund universe of a moderate risk model. Limiting the funds available to a moderate risk model confines its investment choices to funds of moderate risk or less. A conservative model's fund universe will be predominantly bond funds, both corporate and government bonds of all maturities and durations as well as some conservative equity funds or balanced funds. The conservative equity fund affords the model a potentially profitable alternative to bonds during a rising interest rate environment, when debt-oriented funds may decline in value. All models have money market funds as an investment option. During those unique periods when stock and bond portfolios are not performing well, the money market funds are available to help manage risk. It is important to note that money market funds do not have a minimum hold period and the model may re-enter the market at any time. Each model is designed to choose only one asset class/fund at a time.

How many exchanges could I expect per model on an annual basis?

A growth model exchanges on average 4-6 times per year. Moderate risk models will recommend exchanges 2-4 times and conservative models exchange 2-3 times per year. Each model will provide notification of possible future exchange dates at the start of each new holding period.
 
Do you implement a stop-loss in your investment methodology?
The models do not use a stop-loss. Our analysis has shown that while a stop-loss may be appropriate for more active investment strategies, they seldom produce performance gains in The Model Program. Our risk management is achieved through allocation to out performing asset classes, mandatory holding periods, and the ability to rotate to money market funds when necessary.
 
If you have any additional questions about The Model Program or how we use it, please fill out the contact us form.
 
Terminology
 
Alpha - A coefficient measuring the risk-adjusted performance, considering the risk due to the specific security rather than the overall market. A large alpha indicates that the investment has performed better than would be predicted given its other peer group members and sector indexes.
 
Asset Classes - A type of investment, such as stocks, bonds, real estate, or cash.
 
Basic Risk Rankings - the quantifiable likelihood of loss or less-than-expected returns. Examples: Alpha, Beta, Best Return, Worst Return, Average Annual Return, Sector Risk, Investment style.
 
Benchmarks - A standard, used for comparison.
 
Beta -A quantitative measure of the volatility of a given investment relative to the overall market, usually the S&P 500. Specifically, the performance the investment has experienced in the last 5 years as the S&P moved 1% up or down. A beta above 1 is more volatile than the overall market, while a beta below 1 is less volatile.
 
Bottom-up - An investment strategy in which companies are considered based simply on their own merit, without regard for the sectors they are part of or the current economic conditions. A person following this strategy will be looking very closely at the company's management, history, business model, growth prospects and other company characteristics: he or she will not be considering general industry and economic trends and then extrapolating them to the specific company. Followers of this strategy believe that some companies are superior to their peer groups, and will therefore outperform regardless of industry and economic circumstances. The purpose of bottom-up investing is to identify such companies.
 
Conservative Growth - Cautious; having a risk-averse investment strategy which has preservation of capital as a high priority, but also contains growth elements that can participate in market appreciation. All of our investment models contain market related risk. Investors can and will lose principal value if the underlining investments purchased reduce in value. Conservative models typically have more bond positions and traditional investments that are broad or balanced in nature.
 
Core Growth - An investment composition that usually expresses high alpha and is often a high-quality security with a history of fairly steady performance. Core models are used to create diversification in a portfolio and act as a stabilizing force when markets are volatile. Positions in the core models are intended to anchor a portfolio and bring value, but all of our investment models contain market related risk. Investors can and will lose principal value if the underlining investments purchased reduce in value.
  
Indexes - A statistical indicator providing a representation of the value of the securities which constitute it. Indices often serve as barometers for a given market or industry and serve as benchmarks against which financial or economic performance is measured.
 
Investment Groups - a group of Mutual Funds, Annuity Sub-Accounts or Exchange Traded Funds that have been fundamentally evaluated and selected for specific characteristics. Characteristics can be based on many things including, but not limited to: sector correlation, price behavior, correlation to other investments in the group, etc. Investment groups often consist of 5 to 35 individual positions. However, at any given time the model will only select one investment position after having measured and calculated the best probability of making a successful transaction.
 
Investment Platforms - is the custodian company that is offering the trading solution on your account. Examples are: Fidelity, Putnam, American Funds, AIM, Hartford, Oppenheimer, American Skandia, Nationwide, Fiserv Investment Support Services. All of these companies have individual investment platforms that carry investment options that are limited by their specific internal controls. We evaluate each entity and determine if their internal procedures would allow for us to construct investment models that will help us allocate assets with in their programs.
 
Minimum Holding Period - the length of time that a model must hold an investment position once purchased. Typical holding periods are 60 to 135 days per model. The difference in holding period per model is based on the underlining investment grouping that comprises the model. Bonds and lower volatility investments typically have a longer holding period that technology and higher volatility positions. Once a model has completed its minimum holding period, it evaluates the market price data everyday and will either sell the position if there is a stronger place to put the assets or continue to hold that position if the current position is still showing strength.
 
Model - A group of investments that have been fundamentally evaluated and selected for specific characteristics and are then studied by overlaying computerized technology to evaluate additional characteristics that helps to establish a minimum holding period. The minimum hold period is then tested over a number of different market time frames and economic environments to determine if the model has a robust nature that evidences a strong potential that might indicate an ability to continue to make positive transactions in the future. However, no amount of testing can assure a positive outcome. A model will only select one investment choice at a time. Historical indicators do not have to be 100% positive in order for a model to be issued to the model inventory. Actually, it's extremely rare to find a model that has displayed 100% productivity.
 
Moderate Growth - An investment style that looks for positions with medium risk statistics, but has demonstrated strong earnings and/or revenue growth or growth potential. Items in this category typically display a higher level of volatility than Conservative and Core. All of our investment models contain market related risk. Investors can and will lose principal value if the underlining investments purchased reduce in value. Moderate models are often used for individuals that are looking to grow investment funds for time periods longer than 5 years.
 
Objective - The result desired by an investor, such as current income or capital appreciation.
 
Overlap - is the term used to describe concentration into one area or sector of the market. If you have 9 models and 5 of them say to buy the same position or investment sector, your portfolio would be said to carry 55% overlap.(5/9) Overlap can be good if that sector is doing well, but most investors cannot take the risk associated with a 50% exposure to one sector. Therefore, we monitor and manage overlapping positions by either omitting new trades into that sector or replacing an investment that may or may not be related to that specific investment sector.
 
Peer Groups - Other investments in the same category or sector. Often multiple investments are offered with similar business strategy or general industry affiliation. We measure Peer Groups to help find the best performing investment in a given sector.
 
Performance History - The results of investment activities over a given period of time. Often investment performance is quoted by 1, 3, 5, 10 year increments and/or since inception. Our models typically need a 5 year track record of price history to be able to qualify for model inclusion. However, some investments warrant inclusion without a 5 year track record history.
 
Portfolio - A group of models that have been characteristically evaluated and matched together in combination in groups of 3 to 13 models. Portfolios help to diversify account holdings across the best position of each individual model signal. Therefore, if 10 models are running with an account value of One Million Dollars, each model would likely contain around $100,000 per model. Weightings of actual dollar values can differ.
 
Risk Assessment - The monitoring of various risk factors in an investment portfolio to help determine that there are no unwanted or unintended risks in the portfolio that could cause performance surprises.


Top-Down - An investment strategy which first finds the best sectors or industries to invest in, and then searches for the best companies within those sectors or industries. This investing strategy begins with a look at the overall economic picture and then narrows it down to sectors, industries and companies that are expected to perform well. Analysis of the fundamentals of a given security is the final step.


Trade Limitations - Many investment companies have placed restrictions on trading activity. We work with those companies to understand what their restrictions are so that we can construct investment models that adhere to their internal policies. Many mutual funds have 60 to 90 day holding periods and variable annuity companies often limit accounts to 12 to 20 trades per year. This information allows us to determine if the platform is flexible enough to accommodate models. Often, this means annuities can only accommodate 4 or 5 models trading 4 times per year.


Volatility - The relative rate at which the price of a security moves up and down. Volatility is found by calculating the annualized standard deviation of daily change in price. If the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility.

 
Why 9 to 13? - Nine to thirteen models is significant due to the trading experiences that we have evaluated from past market cycles. First, diversification plays a key role in helping to spread investment related risk across many investment categories. When using 9 to 13 models you could expect to have between 3 and 13 different categories at once. When using fewer models, you could expect to see a higher percentage of concentration depending on the models investments from which it can select. If one position has significant negative performance the other positions may help to act as a diversified support to that one position.