A Note from the PM

Dominick Paoloni, CIMA®
Portfolio Manager, IPSAX

The IPS Absolute Return Strategy is uniquely positioned to handle a substantial crash that realistically could be on the horizon.  Most diversified portfolios are short volatility, which means they will continue to perform well as long as the market continues to go up.  However, if volatility (instability in the market) should rise in any meaningful way, for example due to some geo-political event like conflict with North Korea, the losses to investors, especially retirees, could be quite painful.  Although most global portfolios are well diversified, be it ETFs, mutual funds, or equities, at the end of the day these diversified asset classes still have substantial risk exposure to a rise in volatility due to a market crash.

The IPS strategy is always long volatility, which means to you, if we should witness a geopolitical event in a place like North Korea and volatility spikes, the IPS portfolio will benefit, unlike the vast majority of traditional portfolios.

These shocks to the financial system seem to be happening more frequently:  on May 17th with the market dropping almost 2% on the FBI firing; the night of the election, the overnight market was down 800 points on the Dow futures; after the Brexit vote, the market saw close to a 4% drop the next day; in August of 2015, the market dropped over 11% due to China devaluing their currency; and in January 2016, we saw the market drop over 10% on U.S. recession fears.  All of these shocks to the system were followed by a market recovery over the next several days, weeks, and months.  The scary question is:  What will happen to the traditional portfolio when we don’t see an immediate bounce?

Many financial professionals don’t hedge their clients’ portfolios because of the heavy cost associated with holding insurance.  The main approach used to  protect a portfolio is to diversify into assets that hopefully will go up if the market drops, i.e. bonds.

What happens, though, when you combine an eight year bull market in stocks with historically low interest rates and a prevailing expectation that the Fed will continue to raise rates?  You get a lot of speculation that stocks and bonds might both fall in value.  The big concern is:  How will investors react if stocks fall and they also see the bond portion of their portfolio fall?

The IPS portfolio holds hedges (insurance) every month, every week, every day.  We believe it is too late to put on your seat belt after a crash.  You wouldn’t get into a car without wearing a seat belt, so why would you invest without a seat belt?

Can a portfolio consistently hold insurance and make money in up markets?

In May of 2017, the strategy returned 1.15% while the S&P 500 was up 1.16%.  Year-to-date (as of 5/31) the strategy is up 4.21%, while the market is up 7.73%.  The fact that we hold insurance on the portfolio every day and can capture higher returns than a 60/40 stock/bond mix is very exciting.

Many investors ask us when the next market crash is going to occur.  The truth is nobody truly knows.  What I know for a fact is it’s not a question of if, but when the next market crash will happen.  The fact that the IPS strategy holds long insurance protection everyday doesn’t guarantee we won’t lose money in a market crash, but it does give me peace of mind knowing that although a market crash might give us some bumps and bruises, it will not be nearly as traumatic for us as the losses that will be experienced by traditional portfolios.

Remember, our goal is steady, stable growth.  Winning means not losing.  If you lose 50% in a major market event, you will have to make 100% just to get back to breakeven!  The IPS strategy is designed to lose far less in such an event, and recover much quicker.

DISCLAIMER: The information on this website should not be misconstrued as an offer to buy or sell, or a solicitation to buy or sell securities. The performance data represents past performance data. With any investment, past performance is not necessarily indicative of future performance. The Absolute Return Strategy performance is representative of a size-weighted composite of the accounts managed by the firm classified as the Absolute Return Strategy-Moderate composite. The returns represent net returns of clients invested into the strategy, accounting for the 1% annual management fee. Please note that all performance in 2011 represents one non-fee paying account comprised of the firm’s capital. Due to the nature of composite performance, it cannot be guaranteed that an investor in a specific composite will receive the same gains as the size-weighted average of the composite. As of April of 2016, the separately managed accounts in the ARS–Moderate composite gain their exposure to the ARS through a 40 Act fund that utilizes the Absolute Return Strategy. The performance of the ARS shown on this sheet still represents the size-weighted average of the SMA’s that are part of the ARS-Moderate.

The Absolute Return Strategy invests in derivatives securities. Specifically, the fund sells and buys put and call options and sometimes utilizes leverage; these factors can cause portfolios invested in the strategy to show greater fluctuations than investments in the underlying assets. Prior to buying or selling an option, investors must read a copy of the Characteristics & Risks of Standardized Options. Put options give the purchaser the right, not the obligation, to sell a specified number of shares of the underlying security at a specific date in the future. The seller of a put option has the obligation, not the right, to have a number of shares delivered to them at a specified price at a specified date in the future in exchange for receiving a premium upfront for this risk. The seller of a call option has the obligation, not the right, to deliver a specified number of shares to the buyer at a specified price at a specified date in the future in exchange for receiving a premium upfront for this risk. The risk of buying either a put or call option is limited to the premium paid for said option.

The performance of the S&P 500 Index is representative of price returns not including dividends over the specified time period.
The performance of the AGG Index (Bloomberg Barclays US Aggregate Bond Index) is representative of the total return including reinvestment of dividends. These indexes are unmanaged and thus it is impossible to invest directly into these indexes.

One should always consult an investment advisor before making any investment decisions as well as consider the investment’s objectives, risks, charges and expenses carefully before investing or sending money. This and other important information about the Strategy is available upon request.

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