A hedging strategy
The Audacity Strategy is a proprietary investment strategy developed by Mark Patton.
Summary of the strategy characteristics
- 100% U.S. highly liquid stocks
- Hedging strategy – profit from some positions when they go up in value and profit from other positions when they go down in value.
- Behavioral Finance investment principles – all stocks are selected based upon principles to take advantage of others’ poor human behavior.
- Rules-based model – the investment principles are implemented entirely by a set of static mathematical rules, with no human emotion on our part, to take advantage of the behavioral-based principles.
- Uncorrelated Performance – performance that tends to NOT go up and down at the same time and the same way as most other investments resulting in more portfolio diversification benefits.
- Validated by research – the strategy was tested against data back to 1963 implementing the strategy on a daily basis exactly as it is implemented going forward.
Why invest in the Audacity?
Market-beating returnsreseach indicates the Strategy would outperform the S&P 500 in nearly all market environments.
Bear-market risk mitigationthe Audacity has produced POSITIVE returns during multiple periods when the stock market has DECLINED demonstrating its potential to possibly mitigate bear-market losses.
Portfolio diversifierstatistically Audacity has demonstrated low correlation to nearly all other investments (stocks, bonds, etc.) resulting in portfolio diversification benefits of higher expected returns and lower potential risk.
Profiting from human behavior
Behavioral finance is the study of human psychology and its impact on the investment decision making process. The Audacity Strategy is designed to systematically, through a set of static rules, take advantage of the poor decision making of other investors.
O1 Human behavior impacts stock prices (more shorter-term than longer-term) – this belief is supported by the following:
- Markets are NOT always efficient
- Investors are NOT always rational
- Stock prices are NOT always perfectly priced
O2 Human behavior is repetitive – the names and faces change over time and the behaviors are never exactly the same from day-to-day but general human behavior tends to be repetitive.
O3 A strict, static (unchanging), rules-based (mathematical) strategy is the only way to systematically profit from pricing inefficiencies resulting from human behavior.
O4 Pricing inefficiencies resulting from human behavior persist because there is no perfect arbitrage. In other words, there is no perfect way to take advantage of the pricing inefficiencies.
O5 Profiting from behavioral-based strategy requires accepting risk because of the imperfect nature of human behavior. Human behavior is not always consistent, which can result in short-term losses, but tends to be repetitive over time which will drive long-term profits.
The Audacity Strategy is a turbocharged (more leveraged) version of Patton's predecessor hedging strategy, the Patton Flex Strategy, designed to further increase long-term returns. The Patton Flex Strategy has proven successful since its launch in February 2010. In addition to the many years of proven success of the Flex Strategy, both Audacity and Flex are supported by research spanning more than 5 decades of market data.
A Portfolio Diversifier
A well-diversified portfolio is one that has multiple investments that all are expected to go higher over time but do NOT all go higher at the SAME time. Generally, all investments provide diversification value in a portfolio but some much more than others. The accompanying graph shows the diversification impact of various investments on a portfolio.
This is NOT about the return of various investments but instead about difference in the performance BEHAVIOR of each investment. The LESS similar an investment's behavior is to other investments, the MORE impact it has on the diversification of the portfolio.
Assuming you start with a portfolio of large U.S. stocks, the below graph shows the diversification impact of adding various asset classes to the portfolio. As the graph show, the Audacity Strategy provides some of the greatest diversification value.
Diversification often requires a sacrifice of long-term returns. For example, investing in bonds provides much added diversification to a portfolio but often results in sacrificing long-term returns. The Audacity Strategy is expected to deliver BOTH much added diversification AND strong long-term returns resulting in better long-term portfolio returns.
Strong returns supported by research
In addition to providing the expectation of additional portfolio diversification, the Audacity Strategy is expected to procude very strong long-term return.
The strong returns of our predecessor Strategy since its launch in 2010 are supported by decades of research. This research tested the implementation of the strict mathematical rules of the Audacity Strategy applied the same way every day since July 1963. The results from this research show that these disciplines would have produced strong returns and added portfolio diversification over multiple decades.
Bear-market risk mitigation
The purpose of a hedging strategy such as our Audacity Strategy is to help mitigate some downside risk in a portfolio. Audacity is designed to do so and has demonstrated success both since its inception and in our extensive research.
Statistically there are multiple ways to measure a strategy’s ability to mitigate some downside risk. One simple way is to look at the months when the stock market was lower and compare how the Audacity Strategy performed during these down market months. The accompanying graph shows the results.