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Thomas J. Feeney
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Tom Feeney began his work in the investment industry in 1969. Clients have included cities, states and major corporations, as well as numerous religious, charitable and other not-for-profit organizations. In his early career Tom served as Executive Director of Stewardship Services, Inc.,... More
My company:
Mission Management & Trust Co.
My blog:
Measure of Value
  • Frequency Of Transactions Reflects Cautiousness 0 comments
    Dec 6, 2013 7:17 PM

    Since introducing our formularized equity allocation processes in late-2012, we have had numerous opportunities to hear opinions and to field questions from clients and non-clients alike. A very high percentage of clients have chosen to add one of the two allocation methods to the equity segments of their portfolios. Fortunately, year-to-date the processes have produced a double-digit return while exposed to equity risk less than 40% of the time.

    A few weeks ago the chairman of a large non-profit's investment committee suggested the 3-Mode to be essentially a trading vehicle. Our meeting was his first exposure to the process, and the frequency of signal changes (an average of 16 per year over the past 33 years) could logically lead to that perception. My response addressed his concern by explaining how the method differs very substantially from trading.

    Most traders buy or sell a security or an index based largely on attractive technical factors with a fairly specific price target in mind. Fundamental considerations may well also be evaluated but rarely dominate the decision-making process. Our execution of the 3-Mode process is demonstrably different from a typical trade.

    When the process issues a buy or sell signal, it does so with neither price nor time target in mind. Through a measurement of dozens of fundamental and technical factors, the process merely indicates that the equity markets are more likely to rise or to fall in the indefinite period ahead so long as conditions remain as they are currently. Over 33 years of observation, such signals have lasted for well more than a year and, in a few instances, for as little as a single day. At the time a signal is produced, nothing indicates the likelihood of a long or short time period. Changes in conditions dictate the longevity of a signal.

    When we describe the process as "formularized", we've had some people question whether this is a kind of black box magic. It's far from that.

    How do most investment analysts, strategists and managers make their security selection decisions? Most evaluate a collection of macro conditions and a variety of security specific data. Since we employ exchange-traded funds replicating the results of broad stock market indexes, we can skip considerations specific to individual companies and concentrate on factors that affect the overall market.

    While some investment professionals focus on just one or a small number of critical fundamental and/or technical conditions, most examine a broad array of factors in determining the attractiveness of the environment for stock ownership. We similarly examine a very large number of economic and market related factors, mostly domestic but some international, some fundamental and some technical. The data that we evaluate are widely reported and are critical to the investment decisions of the majority of investors.

    Like most investment professionals, we consider money and credit conditions to be very important. We assess Fed policy, rates of money growth, the availability of funds for investment, rates of inflation and changes in interest rates at several points along the curve.

    Investor sentiment provides a meaningful contrary weight in our analysis. We assess traditional valuation measures, market-wide stock earnings yields, overbought / oversold statistics and a collection of sentiment surveys.

    Over the years we have been impressed with the predictive accuracy of several outside data studies, both domestic and international. We buy a number of those, and a few are included as components of the equity allocation processes.

    Notwithstanding the predictive ability of a great many studies as well as evaluations of individual economic or market conditions, virtually all have experienced one or more major failures if traced back over the decades. Not-for-profit institutions and retirees comprise the bulk of our clientele, and neither can easily replace significant amounts of lost capital. The make up of our client base created a need to guard against even a single substantial loss. While the investment markets don't lend themselves to guarantees, we had to be sure that the processes had a very high probability of avoiding unacceptable losses.

    Prior to offering the equity allocation processes to our clientele, we had to uncover what we have categorized as the last piece of the puzzle. By including a heavy weighting of measures of price movement and price momentum, we were satisfied that we had an approach that had strong potential to outperform major equity indexes over full market cycles. Most importantly, in back-testing for nearly a third of a century, we found that our combination of factors not only outperformed equity indexes in the long run, but did so with fewer and smaller losses, a necessity for our clientele.

    Nothing in our analysis is unique or even uncommon. The major difference between Mission and most other managers is not the data that we evaluate. We simply quantify the results of our many studies, rather than relying on a more subjective evaluation of their findings. That quantification serves the valuable purpose of eliminating ego and emotion from the investment decision-making process. Neither newspaper headlines nor an endless stream of talking heads on financial TV play a role. The processes provide a positive signal when the cumulative array of data produce a level of strength that, over the past 33 years, have coincided with periods of positive market progress with a relatively high degree of probability. Conversely, negative signals occur when the cumulative data coincide with the readings they have provided when markets have declined over the past third of a century. Neither these processes nor any other decision-making process can guarantee positive results, but we have chosen to let carefully documented historical probability over a great variety of market environments dictate our equity allocation decisions.

    While back-tested results can never predict the future with certainty, we believe these formularized approaches will continue to provide positive results for three reasons: 1) the results have been obtained with considerable consistency over more than three decades in quite a variety of market environments; 2) the factors evaluated are numerous and diverse, so a few becoming less well correlated with market success or failure will not likely eliminate the effectiveness of the overall formula; and 3) the heavy weighting of price movement and price momentum has been quite successful in avoiding significant losses when most of the factors are pointing in one direction but prices are moving in the opposite direction.

    Let me return to the original question. Is the 3-Mode process just a trading vehicle? Our 2-Mode and 3-Mode processes evaluate exactly the same data. The 2-Mode has historically experienced an average of just one signal change per year, far from typical trading frequency. The 3-Mode averages 16 signal changes per year, because it has far tighter risk tolerances. It moves out of a long or short position when the data become less certain. It is willing to forego some profit on either the long or short side when predictability declines. As a result, it has achieved an annualized return of about 400 basis points above the S&P 500 without having experienced even a single double-digit loss in a calendar quarter, compared to eleven such losses for the unmanaged S&P 500. More frequent transactions for the 3-Mode are a function of significant cautiousness rather than traditional trading tactics.

    Please contact us if you would like more information about either or both of these equity allocation processes.

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