March 2014 Performance

Monthly Review 201403 bbd

March Overview

The S&P took a deep breath in March, first rallying, the selling off, then repeating itself until it closed with a small gain. That was not the case for NASDAQ, which started on a positive note but headed south the rest of the month (see the chart below, SPY on the left scale and QQQ on the right). NASDAQ had benefited from exceptionally good returns in biotech and other hi-tech markets, but outperformance on the upside will also mean higher volatility on the downside. The chart of BBH, a biotech ETF, shows a drop of 15% off the highs, all in 2014. With our stock portfolios equally in NASDAQ and NYSE outperformers, our March results reflect that downturn.

SPY-QQQ March 2014

Biotech ETF

Of our three daily equity programs, 7 of 11 were profitable in March, but none of the 4 weekly equity programs were profitable. In futures, the Trend program posted 3 of 3 losses, but the Divergence showed 3 of 3 gains. The 3 Weekly Futures portfolios all showed losses. While the Trend program posted the largest losses, it followed large gains and is still far ahead of the benchmark SPY and QQQ ETFs for 2014. Even on a sunny day, a little rain may fall.

The most difficult performance remains the Futures Trend program, typical of the industry, but still not satisfying. The Newedge CTA Trend index was down -2.13% for March and off -5.94% for 2014. Kaufman Signals has decided that something new is needed, and we are now finalizing a dynamic portfolio allocation method for futures.

A Standing Note on Short Sales

Note that the “All Signals” reports show short sales in stocks and ETFs, even though shorts are not taken in the portfolios. Our recent review of using inverse ETFs to hedge stocks during a decline showed that downturns in the stock market have been short-lived and it is difficult to capture those moves with trend systems. This confirms our approach to the Timing systems, which hedges up to 50% of the long stock risk using multiple trends. In the long run, returns from the hedges are net losses; however, during 2008 the gains were a welcome risk reduction. In this case we prefer paying for risk insurance, even without the expectation of any significant gain from it.

PEFORMANCE BY GROUP

NOTE that the charts shown below represent performance “tracking,” that is, the oldest results are simulated but the newer returns are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance.

Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks and ETFs

The Trend program seeks long-term directional changes in markets and chooses stocks and ETFs that have performance over many years combined with good short-term returns.

Usually the best performers, the Trend program reacted to the reversal in those markets that were the biggest gainers and the most volatile over the past year. While it doesn’t look like much of a reversal on the chart below, I can assure you that it was unpleasant, especially after such a long run of gains.

The ETF program is a based on sector rotation. For the Trend, this means buying the strongest performers. Nevertheless, choosing 5 of 15 sectors will track closer to the broad index than individual stocks. Instead, it offers lower volatility, a higher information ratio, and the ability to mix in a portfolio of other strategies. For those of you who didn’t notice, we’ve added another ETF to this program, so that we hold 6 rather than 5. This adds additional stability to the returns.

The charts below show the remarkable rise during past few years, the results of choosing high beta stocks with persistence. We need to remember that high-beta portfolios will also have larger drawdowns alternating with larger gains, and the smaller 10 stock portfolio will have even greater concentration in high beta stocks.

DE1 Charts Mar 2014

Weekly NAVs look similar to Daily, as seen in the charts below, with losses in all portfolios, much the same as the Daily program. It is difficult to imagine continued outperformance without some consolidation; however, we can’t ever know when that will happen. One of the major features of trend following is capturing the “fat tail,” those exceptionally long winning streaks that cannot be predicted. In fact, they can only happen when least expected.

Weekly Trend stocks and ETFs Mar 2014

Group DE2: Divergence Program for Stocks and ETFs

The Divergence program looks for patterns where price and momentum diverge, then takes a position in anticipation of the pattern resolving itself in a predictable direction, often the way prices had moved before the period of uncertainty.

 March posted small gains for the stock portfolios, and a fractional gain for ETFs. The stock portfolios were slightly better than the broad index markets, and maintain their long-term advantage. It should be noted that the 30-stock portfolio generally underperforms the 10-stock portfolio, but has significantly less great, the consequence of diversification and less concentration in the extreme high-beta stocks.

Divergence stock and ETF Mar 2014

Group DE3: Timing Program for Stocks and ETF Rotation

The Timing program is a relative value arbitrage, taking advantage of undervalued stocks relative to its index. Its primary advantage is that it doesn’t depend on the market direction for profits, although these portfolios are long-only because they are most often used in retirement accounts. When the broad market index turns down, this program hedges part of the portfolio risk. The ETF Rotation program buys undervalued sectors, expecting them to outperform the other sectors.

This program maintained its history of modest gains in March, with small profits in each of the three portfolios. Unlike the Trend program, the Timing program buys stocks at a discount to the SPY, QQQ, or IWM, depending on which index it tracks. Therefore, it will not buy the biotech stocks until they are underperforming the overall market. For this month, that prevented a volatile performance.

There were no hedges placed in March due to strong trends in all three major index markets.

The ETF rotation portfolio has a strategy contrary to the Trend Rotation. This one buys undervalued ETFs while the Trend program buys the outperformers. While the Trend program can achieve high returns with high risk by selecting from a broad range of stocks, the Timing program targets moderate returns with low risk. Not all stocks qualify because they do not necessary track any index.

In many cases, the 30-stock portfolio will not be completely filled; therefore, returns will be somewhat muted. Out of the approximately 220 stocks tracked, there may not be enough trading signals satisfying the two performance criteria plus a current open position. Then the 10-stock portfolio may always be filled but the 30-stock may be filled an average of only 75%. This will dampen the monthly returns whether they are gains or losses.

Timing charts Mar 2014

Groups DF1 and WF1: Daily and Weekly Trend Program for Futures

Futures allow both high leverage and true diversification. The larger portfolios, such as $1million, are diversified into both commodities and world index and interest rate markets, in addition to foreign exchange. Its performance is not expected to track the U.S. stock market and is a hedge in every sense because it is uncorrelated. As the portfolio becomes more diversified its returns are more stable.

The leverage available in futures markets allows us to manage the risk in the portfolio, something not possible to the same degree with stocks. This portfolio targets 14% volatility. Investors interested in lower leverage can simply scale all positions equally in proportion to their volatility preference.

In March, both the daily and weekly trend program turned in a negative return, mostly in-line with Barclays CTA Trend Index, but negative none the less. The bar charts below compare the returns for the Trend and Divergence programs by sector. As we discussed in the section above on new portfolio construction, the Trend program depends heavily on long-term trends in interest rates to drive all futures markets. That is not happening. The interest rate sector posted the largest losses for this program, although the faster Divergence Program did much better.

Futures sector performance

In the big picture, for those investors with a great deal of patience, the Trend Program is still doing well and recent losses are not out-of-line with long-term performance. For the daily program, the $100K account is the most volatile and, surprisingly, the $500K is the most stable. That’s just good fortune, because the larger accounts are always more diversified and tend to have a higher return ratio over time.

The Weekly Program is much more consistent than the daily, benefiting from fewer false entries. All three portfolios are tracking well, considering recent losses.

Trends always appear when we don’t expect them, as we’ve seen in the equity markets. And when they do appear, we don’t believe it until it’s near the end. This trend program will recognize and enter trends without those preconceived notions.

Trend futures charts Mar 2014

Daily Divergence Portfolio for Futures

This program posted profits in 4 of 6 sectors last month, netting a small gain in each portfolio. Most of this performance falls into the predictable pattern of larger portfolios producing smoother but lower returns. The chart below shows the $500K portfolio as the most volatile, but also the one with the best returns.

Divergence Futures Chart Mar 2014

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