All blog content is for information purposes. Any reference to indivisual stocks, indexes, or other securities as well as all graphs and tables are not recommendation but only referenced for illustration purposes.
This has been a frustrating year so far for investors in the Patton Flex. Year-to-date, through August month-end, the Flex is down about 5% while the S&P 500 is higher by almost 8%.
The frustration started in January with a loss of 7.5%. In March, it attempted a recovery that then stalled in April. This was followed by a strong May and June with cumulative gains of more than 10% in those two months that did put it in positive territory year-to-date. Since mid-year, it has been drifting lower.
Although 2016 has so far been negative, let’s remember the long-term performance has been very attractive. As noted in the accompanying graph, the Flex has outperformed the S&P 500 by more than 50% cumulatively since its launch. Furthermore, the Flex’s gains have been accomplished with smaller losses than the S&P 500 during this time.
Year-to-Date Performance…Frustrating? Yes. Unusual? No
No doubt that being down 5% for the year and lagging behind the S&P 500 by 13% is frustrating but it certainly is not unusual. To begin with, a 5% loss during an 8-month period of time for any investment occurs on a fairly regular basis.
To determine if the current performance is unusual or not, I’ve done a lot of research on 8-month returns. Although it is a very short period of time, that’s really all we are talking about in regard to any performance frustrations.
This is the first time since the launch of the Flex Strategy in early 2010 that it’s lost 5% in an 8-month period. It’s relative underperformance of 13% to the S&P 500 though has occurred. As of the end of February 2011, just over a year after the launch, the Flex had produced a gain of just 2.6% while the S&P 500 was higher by 30.5%...an underperformance of nearly 28%! This period of frustration persisted for about a year and was followed by multiple years of outperformance by the Flex Strategy.
For a much long-term perspective on this, I have studied the research performance on the Flex Strategy back to June 1963. The Flex Strategy has an 8-month loss of 5% or worse about 9% of the time…that’s obviously fairly frequent. The statistics are nearly identical when counting the times when the Flex is underperforming the S&P 500 by 13% or more…it’s about 9% of the time.
Comparing the Flex to Other Investments
I think it further helps to understand how the results of the Flex Strategy compare to other investments. Since 1963, the S&P 500 has had an 8-month loss of 5% or more about 17% of the time. Another investment I often find interesting to look at is Berkshire Hathaway, Warren Buffett’s stock…it’s negative 5% or more almost 16% of the time. To make this clear, at any point in time, investors in Berkshire Hathaway have had a 5% loss or worse 16% of the time. Again, the Flex is only 9% of the time.
Clearly the Flex stacks up well here. We have to remember that the losses for the Flex will often not occur at the same time other investments are experiencing losses due to its low correlation. This is by design!
The frequency of negative short-term returns such as these illustrated is true for nearly all investments (single asset classes), especially those with higher long-term return. The simple truth is that if you want to avoid short-term losses, you will have to give up strong positive long-term returns. That’s the tradeoff with nearly any given asset class and it’s certainly no different for our Flex Strategy.
I want to be clear that this truth tends to hold for individual asset classes (you must endure short-term losses for better long-term gains) but not necessarily for a diversified portfolio…that’s a different story where you can reduce some downside risk and get comparable or better returns. That’s the story of our Super-Diversification Strategy for another time.
Why We Invest in the Flex Strategy
It’s important to remember, especially during periods of frustrating short-term performance, why we invest in the Flex Strategy. Here it is:
- Achieving great long-term returns
- Low Correlation – producing returns that are not dependent upon the returns of other investments
The primary goal is to make money and to make more money than we would via other investments with similar risk. The Flex has accomplished this since its launch with returns well in excess of the S&P 500, net of all fees and expenses, as illustrated on the first page, with comparable or less risk depending on how risk is measured.
The secondary goal, which I would argue is nearly as important as the primary, is to produce great long-term returns that are not dependent upon the returns of other investments such as stocks. Statistically speaking, we want returns that have a low correlation to other asset classes. Accomplishing this goal is the real trick and something the Flex has accomplished and continues to demonstrate.
Let’s remember what it means to have returns with a low correlation. It’s simply having returns that do not always go up and down at the same time and with the same magnitude. Low correlation does not mean that two things move in opposite directions. It instead means that that they are generally independent of one another. When one moves up, the other could be up, could be down, or could be sideways…they are independent of one another...that’s what low correlation means. The fact though is that few investments are entirely independent of all other investments so it becomes a matter of degrees.
The Flex Strategy has had a correlation of 0.31 to the S&P 500 since its launch. A zero correlation would indicate complete independence and a 1.00 correlation would suggest one is exactly the same as the other. The Flex’s correlation of 0.31 compares very favorable to the average hedge fund with a like-type strategy that has had correlation closer to 0.84 during the same period. The accompanying graph illustrates the correlation of a variety of asset classes to the S&P 500.
” The act of diversification provides a free lunch of enhanced returns and reduced risk, increasing the likelihood that an investor will stay the course in difficult market environments.”
– David F. Swensen,
Yale Endowment Chief Investment Officer
Statistics are one thing but let’s look at how this has impacted investors in the Flex Strategy since its launch. One of the most recent benefits was 2015 when the Flex produced a gain of 18.6% and the S&P 500 rose only 1.4%. That is low correlation working for us! On a daily basis, we saw it during the market’s reaction to Brexit when stock prices fell sharply and the Flex Strategy gained in value. The full month of June, just a couple of months ago, was another great example with the Flex up 6.1% and stocks were flat.
I can site numerous examples of how the low correlation of the Flex Strategy has helped mitigate the risk in a diversified portfolio but it does cut both ways. There certainly have been many times as well when stocks, for example, go up and the Flex goes down. This is to be expected and is simply part of the give and take in the investment process.
The secondary goal, and reason why we invest, of the Flex Strategy can be easily forgotten but hopefully you are reminded of how incredibly important it is to the long-term success of the Strategy.
The Flex Should Be One of Many Investments
The Flex Strategy was not designed and was never intended to be the only investment in a portfolio. It is intended to be just one piece of a diversified portfolio. The purpose of a diversified portfolio is to have some investments that work better than others during various periods. You do not want a bunch of investments that are all performing well at the same…this would suggest they will likely all perform poorly at the same time! This goes back to having low correlated investments in a portfolio.
Since the launch of the Flex Strategy in 2010, there have been many periods, far more than not, when it has performed meaningfully better than most other investments in a portfolio. Sometimes the Flex will carry the day and sometimes other asset classes must do so. This is one of those times when other things in the portfolio are driving a Super-Diversified Portfolio’s returns.
The longer-term performance of the Flex Strategy, combined with extensive research, strongly supports that the Strategy is built on theories and principles (human behavior) that will continue to deliver. Absolutely nothing is out of the ordinary.
I have the highest possible confidence that the Flex will recover and continue to produce great, long-term market-beating returns. Exactly when…I don’t know! I do know that the story can, and almost always has, changed rapidly so stay tuned.
IMPORTANT NOTICE: INFORMATION ABOUT PAST PERFORMANCE
Not indicative of future returns. Past performance is not indicative of future returns, which may vary. Accordingly, future returns are not guaranteed and there can be no assurance that any Patton Fund, Strategy, or Portfolio (“Patton Investments”) will achieve comparable investment results or its investment objective. You may lose money on your investment in a Patton Investment.
Strategy Developed based on Back-testing. The investment strategy used by the Manager was developed, in part, by back-testing its investment program against past market conditions. In other words, the strategy was designed to succeed based on knowledge of events that occurred in the past. One limitation of such a strategy is that it is inherently focused on the past, and cannot necessarily take account of market conditions that may arise in the future. If future market conditions are different from past market conditions, and if investors behave differently from past investors, the Manager’s investment strategy may not work as anticipated and the Fund may lose money.
Fees and Distributions. The performance information shown reflects the deduction of actual expenses of the applicable Patton Investment for periods during which the Patton Investment has been in operation. The performance figures shown reflect the reinvestment of all dividends, interest and other income, and assume that the applicable Patton Investment has not made any distributions to investors.
Portfolio Characteristics. Portfolio characteristics, including specific holdings, contributors to performance, and country, sector and industry exposure, are shown as of the date indicated only, and are subject to change without notice. Portfolio characteristics are designed to illustrate the application of the Patton Investments’ investment style only, and should not be considered a recommendation.
Third Party Information. Information contained herein is based on data obtained from statistical services, company reports or communications, or other sources. The Patton Investments and Patton Fund Management, the Manager, believe these sources to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness.
IMPORTANT NOTICE: INFORMATION ABOUT BACK-TESTED PAST PERFORMANCE
Performance results may be presented that that pre-dates the commencement of operations of a Patton Investment. Because the Patton Investment was not in operation during certain periods shown, the performance information prior to the date the Patton Investment commenced operations is back-tested performance (sometimes referred to as hypothetical performance).
Patton Flex Strategy Inception Date: February 2010
There are several important factors to consider when reviewing back-tested, or hypothetical, performance information:
Back-tested Performance is Hypothetical. The performance information shown for the Patton Investment you selected includes performance information that is hypothetical, and is not real. As such, the back-tested portion of the performance presentation does not represent the investment performance or the actual Patton Investment or any investors in the Patton Investment. The securities in these hypothetical portfolios were selected with the full benefit of hindsight, after their performance over the period shown was known. It is not likely that similar results could be achieved in the future. The hypothetical portfolios presented here are purely illustrative, and representative only of a small sample of possible future scenarios.
Back-testing is Subject to Limitations. While it is believed that back-tested performance information presented is relevant to evaluating an investment in the Patton Investment, no representation is or could be made that the information presents what the performance results would have been in the past or are likely to be in the future. There are frequently sharp differences between hypothetical performance results and actual performance results subsequently achieved. One limitation of hypothetical performance is that it is generally prepared with the benefit of hindsight. In addition, no hypothetical track record can completely account for the impact of financial risk in actual trading. For example, back-factors that affect markets in general, the impact of fees and expenses, market liquidity and other factors may all of affected actual performance.
Actual Investor Experience Varies. The back-tested results are not indicative of the skill of the Manager. For example, each Patton Investment began trading on the date indicated on the performance presentation. Back-tested performance shown for each Patton Investment reflects hypothetical performance determined using the current investment strategy of the applicable Patton Investment. However, the Manger has been managing money using quantitative strategies since 2001. During this period the Manager has experienced periods of poor performance and the Manager has closed other Patton Investments that it has managed as a result of poor performance. Investors in some of the Manager’s closed funds have lost money.
Indices. The historical performance of various indices, such as the S&P 500 Index, may be included. An index is an unmanaged, broad-based market index and investing in the Patton Edge Strategy is not similar to investing in an index. An index is not available for direct investment, and the securities in an index will not match the Strategy's holdings. In addition, unlike an index, the Strategy's performance will be affected by fees and expenses.
Forward-looking Statements. Any forward-looking statements represent the subjective views of Patton and their validity may be affected by events and conditions not now contemplated and by other factors, many of which may be beyond the Manager's control. Actual results may vary and such variations may be material, and no representation or warranty is made regarding any forward-looking information contained herein.