Monthly Archives: May 2016

May 2016

How the Naked Alpha Fund will fare during future market crashes

By |2019-03-11T19:24:58+00:00May 25th, 2016|

In 2015, our “pooled investment vehicle” (aka hedge fund) The Naked Alpha Fund had its worst performance yet – even worse than 2008. Last fall, we set out to determine why, after the fund’s unit value had fallen 16.9% from the final week of June through September.

We discovered that our mechanism for hedging our stock exposure wasn’t as effective as we’d planned. As just a few of our holdings were plummeting, the indexes that we had purchased insurance against dropping were holding up rather well, comparatively. Our original premise had been that if we sell puts on enough stocks, our portfolio should resemble the S&P 500; hence, buying insurance using S&P 500 Index puts should work.

2015 proved we were wrong in our assumptions. We normally sell puts on 20-30 stocks at a time, giving us a representative sampling of the S&P 500 – that in 2015 proved NOT to mimic moves of the S&P 500 as a whole. Last year, the largest and most influential stocks held up well (see FANG stocks) while a few of our holdings (see TWTR, MU, SNDK, QCOM) crashed as much or more than 50%.

So, in October of 2015, we decided to change the way that we hedge our short put positions. Instead of buying puts on the index, we buy puts on the same stocks that we’re selling puts on. It’s called a “vertical put spread” in the options-trading world. This way, if we sell puts on a stock that plummets, our downside is limited in each and every case.

Where we are today is far more comfortable than 2015 and prior, knowing the downside of each of our positions. We still, however, also initiate cost-less collars for next January, creating additional UN-HEDGED exposure in our portfolio. These collars have on average 18% protection built-in, so it’s fairly benign risk at this point. The benefit of these un-hedged collars is that we participate in much of the upside if the stocks we’re exposed to have a good run between now and January.

What this has all culminated in is the ability for us to predict how the Naked Alpha Fund will react to down markets in the next 30-60 days. We now have a pretty good estimate of what the NAF return will look like if stock markets begin to drop. Here is a snapshot of our estimations for the portfolio as of 5/25/2016:

Stocks down 5% – NAF eeks out approximately +0.8% positive return

Stocks down 10% – NAF will drop approximately 4.5%

Stocks down 15% – NAF will drop approximately 8.6%

Stocks down 20% – NAF will drop approximately 11.5%

Stocks down 25% – NAF will drop approximately 14.4%

This gives not only our clients peace of mind knowing the most undesirable outcomes possible, but due to our hedging methodology change, our manager can better gauge the inherent risk of the portfolio.

Generating Sustainable Income

By |2019-03-11T19:24:58+00:00May 2nd, 2016|

We’ve been working for the past year or so on developing a simple, cost-effective way to generate income for clients in retirement. In years past, you could simply ladder investment grade corporate or U.S. Treasury bonds, and earn a nice 5-7% yield on your portfolio with very little risk.

However, since 2008, the Federal Reserve, in its attempt to keep the economy growing, has set it’s overnight lending rate to banks at zero percent. This key interest rate has influenced interest rates the world over. And while you can now borrow to purchase at house at sub-4%, the losers in a low-interest rate environment are retirees attempting to live off the income generated by their savings.

Enter Sustainable Income Portfolios, or what we call SIPs. We have developed 8 optimized SIPs ranging from ultra-conservative to aggressive, that aim to provide investors inflation-adjusted income, indefinitely. The more aggressive you go on the scale, the more principal fluctuation you are likely to endure. However, as in any investment, the lower the risk, the lower the potential reward.

Currently (as of 5/2/2016), all of our SIPs generate income between 2.9% and 6.5% in annual distributed income. There is potential for price appreciation in all but the most conservative SIP.

The ultra-conservative SIP that provides the 2.9% yield is best suited to those investors looking to protect principal, but yearning for more yield than a bank will provide. The other seven SIPs should all be able to keep up with inflation as asset prices rise, in addition to the monthly income they provide. The most aggressive SIP has the potential for a total annual return of up to 11%, based on past returns and volatility.

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