Advisor Mike Shell has meticulously researched the ways in which price trends can be applied to an investing methodology. He explains how his system has outperformed the S&P 500 over the past seven years, and why he does not rely on fundamentals or macroeconomic forecasts.
Kate Stalter: Today, I am on the phone with Mike Shell of Shell Capital Management.
Mike, I wanted to introduce you today by explaining to our audience that you originally started out a few years ago using some basic fundamentals and chart metrics to identify growth stocks. But you eventually refined some of these methods, developed your own proprietary system to understand some of the probability for many of these occurrences that investors are looking for. What led you to do your own research and to develop your own indicators?
Mike Shell: That's exactly right, Kate. A few years ago-I guess about eight or ten years ago-we were doing charting and technical analysis and various quantitative screens and filters using both technical and fundamental indicators. And one day, a friend of mine said, "Well, how do you know this will really work in the future?" And that's when we started down the probability side with that.
You know, a lot of people talk about chart patterns and various screens and filters, where they say, "You buy this here using these criteria, or sell that with these criteria." That's good. So we just wanted to quantify what is good versus what is bad.
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The only way to do that is to mathematically quantify it by saying, "OK, if our systems enter based on this certain parameter and indicator, and sell based on these parameters and indicators, what is the actual outcome if they have done that over the last 50 years or 70 years"-whatever the data time frame is.
Really, at the end of the day, what you are doing is, you are determining the probability and the mathematical expectation, which is the probability of how often it loses. And the mathematical expectation is how much wins when it wins, and how much it loses when it loses. So that is the probability side of it.
What we do that is unique, and have been doing for the last several years-I think we've got seven years of performance history on our managed account program now-is that we have quantified what we do, and so we have a mathematical basis behind doing what we do. And that is unique from others who are just maybe macroeconomic indicators and things like that.
Since all of this is price-based; all of what we do is primarily price-based, we were able to quantify it that way. In other words, anything that you do that is different from the actual direction of the price itself-so if we are in an exchange traded fund position and it is moving up, anything that you use that is not related to the actual direction of the price always has the potential to veer way away from reality.
For example, value people would think, "Well, it's very undervalued," and maybe it could be, but you don't really know that in advance. It could go down a whole lot more-think Lehman Brothers and Enron and Bear Stearns and all these other things in the past.
Anything that you use that is other than the actual direction of the price itself has the potential to steer you down the wrong path, and almost all blowups in history have been a result of people thinking something was really undervalued, and they buy more and more of it. And of course, they dig a big hole and get caught in the loss trap, and maybe take years and years to ever get back.
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Kate Stalter: Mike, you run what is called your Asymmetry Investment Program, using separately managed accounts. Can you say a little bit about that?
Mike Shell: Yeah, the Asymmetry Investment Program-we named it Asymmetry, by the way, because Asymmetry references imbalance. The funny thing is, a lot of times, the conventional wisdom says you want to balance your assets; you want to balance risk and reward and you want balance in your portfolio.
But the fact of the matter is, you actually want imbalance. We want more gains and less losses, and so through asymmetry, we focus on the outcome of achieving greater profits- more of the profits, less of the downside that we would really prefer to avoid.
And we do that through a very complex risk-management system, primarily; and so Asymmetry Investment Program is our pursuit of asymmetric returns, meaning higher total return over time, less of the downside.
And Asymmetry Investment Program is a managed account program, meaning it's a model portfolio that we offer across several different platforms-Trust Company of America, Folio Institutional, Schwab Institutional, Fidelity, Pershing, and some others. And a lot of those are through an investment advisors or financial planners.
I manage the money. Financial planners access our program through an agreement with us. And then their clients a lot of times have accounts with these different brokerage firms.
Kate Stalter: Now you were talking about some of the gains or losses that you're measuring for. I'm curious: Do fundamentals play a role in your methodology at all at this point, Mike?
Mike Shell: The funny thing is: What we found, is fundamental metrics, like I said before, are things that are derivative of price. And so what we primarily focus on is price trends, and we do that not because of some opinion or bias that I have. We did that because I tested thousands-maybe millions-of different model systems years ago, and continue to do that to some extent now.
By the way, somebody mentioned this morning-made mention of doing research, and I said, "Research is for people who don't know what to do." We don't do a lot of research anymore. We pretty much know what to do.
But we ended up with systems that are focused on price trends and the direction of those price trends. We want to buy and be into things that are going up, and sell and be out of the things that are going down. That is essentially the simple way of what we do.
We primarily do that based on the direction of price trends, because most of the fundamental metrics did not accomplish the things we wanted to accomplish, to be able to quantify the kind of asymmetric returns we are looking for.
In other words, we needed entry and exit and position-size methodologies that would allow us to skew the risk-reward profile, that would allow us to end up with a larger magnitude of profits than losses. And that ends up being; and we think of that as a trade blend with a larger magnitude of profits than losses.
So, we wanted to quantify systems that would allow us to skew our profits and losses; in other words, focus on the magnitude of the profits and the losses at the trade level.
If you think about your average individual trade, nets out at more profits than losses over time, that essentially results in an asymmetric return profile. And that ultimately means that-say, for example over the past seven years, our asymmetric program R15 model has been at 90% total return the past seven years, as of March 2012.
And we had a maximum drawdown of 14%. It means that the most it ever declined at any given point day to day was 14%. Well that's what we call asymmetry.
So you've got a 14% drawdown risk level, versus a 90% total return over that period of time. Over the same time frame, by the way, the S&P 500 has gained about maybe 34% total return, and of course it dropped about 56%. It is not the kind of asymmetry most people want. Most people want less drawdown, less downside, more of the upside.
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So we are actively trying to skew that outcome through the process of buying and selling things. And in doing that, we focus on directional trends, price trends, because those are things that we can truly quantify.
In other words, if we did use some fundamental method, the downside there is that fundamental opinion or that metric that is fundamental, always has the potential to be far away from the reality of the what the direction of the prices are. So that's the downside to the fundamental side of things, and that's just what we discovered through our systematic research process, and so that's where we are today. We focus on price trends.
Kate Stalter: Does volume factor into your analysis in any way, Mike?
Mike Shell: You know, that's a good question. Back in the day, ten years ago, when I was using a lot of technical analysis and volume-it did back then. But we found is that no, now it does not.
Where volume comes in-we're mostly trading exchange traded funds; so we're rotating into ETFs that are going up and out of the ones, the ETFs, that are going down. And so where volume does come into play is that we require that they actually have a sufficient trading volume that provides us with the liquidity that we need to buy and sell.
We don't buy and sell that often, really; it's not like a day-trading thing or anything like that. But we need liquidity to be able to buy and sell. So that's really the only use we have with volume.
Kate Stalter: You sent me a document, which was pointing out what you were talking about a moment ago, about the outperformance of the Asymmetry R15 relative to some benchmark indexes. Now in there, there is something interesting that I found: You don't use margin and you don't sell short. Say a little bit about that.
Mike Shell: Well, we don't use margin in the accounts. You know, the Asymmetry R15 model is a fairly low-risk program, and so most of the people in the accounts are radiologists and surgeons, people in so-and-so businesses. We don't have a lot of need to use margin. We are getting the kind of return we want without having the risk margin.
Regarding selling short, since we don't use margin, we don't even have margin on the accounts. We don't sell short. However, what we do: We can sell short the inverse ETFs; so we can trade securities like, say, ProShares Short S&P 500 (SH), which is intended to achieve 1x the reverse of the S&P500. So we can buy long a position in SH, and it would be expected to go up when the S&P 500 goes down.
So we don't outright short anything, mainly just because we're managing real people's money and retirement accounts, and a lot of times trust accounts and things like that. So we just keep that program really clean and simple, and it is just the nature of what we are trying to accomplish for these people.
Kate Stalter: So Mike, a moment ago, you were talking about some of the various platforms that your program is available on, and I understand that you are beginning to do some more expansion of this program for advisors. Can you talk about that?
Mike Shell: Yes Kate; we are making the program available through financial planners and wealth managers, independent investment advisors who custody. These are registered investment advisory firms who custody accounts at some of the main platforms, like Folio Institutional, Trust Company of America, Schwab Institutional, Fidelity, Pershing, and we are on several different platforms like that.
So we just recently hired some people; that will be announced in the next week. Actually, by next Monday, we'll make an announcement on that. We've recently hired some people that will be heading up this program, and we are going to offer our managed accounts through independent advisors. And that is going to allow us to branch out and offer our money management to more people. And it is going to be all over the country.
So that's the way I feel like it is going to be our best bet for doing it. People have relationships with independent advisors, and in that way the advisors would hire us to manage their client accounts.