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May was a tough month for investors in our Flex Strategy. Since the Strategy’s launch in January 2010, there have only been two other months worse than May’s roughly -12% decline.
Primary Factor Driving Performance
Because the Flex Strategy has both long positions (profit when prices move higher) and short positions (profit when prices move lower), the factors driving performance, good or bad, differ from period-to-period. In May, the majority of the losses were the result of the use of leverage combined with our long positions going down. Here is a simplified illustration:
The average stock in the S&P 500 declined -3.8% in May. Let’s assume, for illustration purposes, that our average long position is similar to the average S&P 500 stock and fell -3.8% for the month. Let’s combine this with the impact of leverage remembering that leverage amplifies performance. At the start of the month our longs were leveraged about 2.5 times. Here is how this math works:
Approximate Impact from Long PositionsAverage stock down -3.8% x 2.5 times leverage = -9.5% loss
Without getting too deep into the weeds, the above, again, is a simplified explanation of the primary driver of performance in May…the long positions went down and we owned a lot of them.
17 Similar Losses Since 2010
Although May was the third worst month in more than 13 years, declines of this magnitude and pace are a bit more common than this would suggest. Here is what May looked like day-by-day:
As the above graph shows, the Strategy was down just -1.1% mid-month. It was the latter part of the month, or the last 13 trading days of May, when the majority of the losses occurred. Looking back at the Strategy’s performance history, there have been 17 other times when losses were similar or worse during a similar number of days. In other words, over the Strategy’s more than 13-year history, such performance has occurred more than once a year.
Focusing on the Long-Term
The Flex Strategy is unique in that it delivers two things to investors:
- 1.) superior long-term performance
- 2.) low R-squared (see callout “R-squared Explained”) to stocks and nearly all other investments.
Since the launch of the Strategy in 2010, the Flex has produced a cumulative return net of an estimated 1.5% annual management fee, of +484.7% as compared to the S&P 500’s +405.9% (even after the difficult May!).
R-squared ExplainedR-squared is a statistic measuring how much of the price movement of one investment is explained by another investment. The value ranges from 0% - 100%. For example, if a mutual fund has an R-squared of 90% to the S&P 500, this means that 90% of the mutual fund’s performance is explained by the performance of the S&P 500.
The second point, that the Strategy has a low R-squared to stocks (see the “R-squared Explained”), is extremely important and unique. This is “investment geek” stuff and incredibly important to our long-term performance expectations! The Flex Strategy’s R-squared to the S&P 500 is 14.5% meaning that only 14.5% of the Flex’s performance is explained by the performance of the S&P 500. Essentially, it suggests the S&P 500’s performance is nearly inconsequential to the performance of the Flex.
The Flex Strategy’s low R-squared to the S&P 500 is important for two reasons. First, it tells us that the bull market for the S&P 500 that has existed for the majority of the time since the launch of the Flex in 2010 was not the reason for the Flex’s long-term strong performance. Therefore, the Flex could continue to deliver strong long-term returns even if the bull market in stocks does not persist. In other words, the strong performance of the Flex is not dependent on a bull market.
The second reason a low R-squared is important is that, just like the Flex is not dependent on a bull market in stocks to perform well, it is not at significant risk of a bear market in stocks as well. As 2022 demonstrated, the Flex Strategy was little changed in value while the S&P 500 and NASDAQ fell sharply.
The fact is that you usually only get one or the other…strong long-term performance or a low R-squared but seldom both. The Flex is delivering both.
What’s next – June 2-day bounce
I wish I could see the future but I cannot! I do know that the first two days of June recovered about one-third of the loss in May. The recoveries from such losses can be very fast but they also can drag on for a while.
Every bit of research and real-time experience suggest the Flex Strategy will continue to deliver great long-term performance and add diversification and overall risk reduction to a portfolio.
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.
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