The model is working! It’s just not performing the way we want it to right now. As much as I hate the performance during the first six months of 2018, it is entirely normal. We’ve been here before and should expect to be here again.

Big Picture

Our Patton Flex has produced a great long-term return since its inception more than 8 years ago. The compounded return has exceeded the S&P 500 by a relatively wide margin and continues to in spite of a disappointing first half of 2018.

To put the performance of the Flex in perspective, based on research we did earlier this year of the biggest database of funds in the world, funds that are in the same investment category as our Flex, the Flex has performed in the top 1% of all similar funds in the world¹. This is success that we are very excited about and is not at all diminished by the recent short-term performance.

2018 Year-to-Date

As of June month-end, the Flex Strategy has a year-to-date loss of -4.82%. This compares to the S&P 500 up +2.64% during the same time. Therefore, the Flex has underperformed the S&P 500 by -7.46% year-date. This -7.46% gap in performance relative to the S&P 500 is not unusual.

The accompany graph shows all of the 6-month periods, the most recent on the far right ending June 2018, when the Flex underperformed the S&P 500. The Flex underperforming the S&P 500 by -7.5% is not common but certainly is not unusual. Since the launch of the Flex more than 8 years ago, it has experienced such performance about every 2 years.

The negative performance of the Flex so far in 2018 while the S&P 500 has inched higher also demonstrates the Flex’s low correlation to the S&P 500 which is one of its great characteristics. Statistically, low correlation means that two things do not always move up and down together. This makes the Flex a great diversifier in a portfolio because it can sometimes go up when other investments go down which it has done many times. This also means that the Flex can go down when other things go up like it has during the first half of 2018.

Video: more details about the last 6 months

For those of you who are interested, I highlight in the accompanying video some individual stocks, sector trends, and more helping further explain the performance of the Flex during early 2018.

Are we out of the woods?

There is no way to know if we are out of the woods yet or not. The underperformance of the Flex could continue. There are simply no guarantees.

That said, the following graph shows the performance of the Flex versus the S&P 500 during the 12 months following the worst performance 6-month periods (highlighted above). As the first bar on this graph shows, after having underperformed the S&P 500 for the 6 months ending December 2010, the Flex then outperformed the S&P 500 during the next 12 months by +15.4%. There was similar outperformance in every example.

Conclusion

I hate it when the Flex goes down but it’s perfectly normal performance behavior.

Achieving great long-term returns is not at all easy. It requires patience during relatively short-term periods when there will be underperformance. And it requires confidence during these times that the investment strategy is continuing to perform and behave as expected. I believe the Flex is doing exactly as we should expect and, therefore, will continue to produce great long-term performance we will all benefit from.

 

¹ www.HFRDatabase.com as of 1/29/2018 had data on 7,046 total funds of which 9 (U.S. Equity Hedge non-sector) had better returns than the Flex since the Flex inception.

² Performance is net of the performance-based fee available only to qualified investors. The return is higher for investors only paying a management fee.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Any specific securities or investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own situation before making any investment decision including whether to retain an investment adviser.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions.  Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. This content was created as of the specific date indicated and reflects the author’s views as of that date. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results.  Any comments about the performance of securities, markets, or indexes and any opinions presented are not to be viewed as indicators of future performance.

Investing involves risk including loss of principal.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. For more information on specific indexes please see full disclosure here.

Any charts, tables, forecasts, etc. contained herein are for illustrative purposes only, may be based upon proprietary research, and are developed through analysis of historical public data.

All corporate names shown above are for illustrative purposes only and are NOT recommendations.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.