Markowitz’s Modern Portfolio Theory: What Investors Get Wrong

In its simplest interpretation, Harry Markowitz’s modern portfolio theory demonstrates that greater risk is positively correlated with return and thus greater risk provides investors with a greater return.

Yet numerous research papers, including research by S&P Dow Jones Indices, show that this just isn’t true. In fact, higher-risk equities tend to produce lower investment returns versus lower-risk equities over full market cycles.

Read more through this article published by Bryce Sutton, Managing Director, Summit Global Investments

 

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2016 – The Year of Unknown Risks

As we prepare to ring in the New Year, 2016 is positioned to be a year of unknown risks, both economically and politically. Recently global terror has dominated the news cycle, with the attacks in Paris sparking some of the strongest security concerns in 15 years and new threats emerging each day. Terror threats like these form an atmosphere of uncertainty and heightened political risk, especially heading into a U.S. presidential election year.

The 2016 presidential race is a source a great uncertainty in and of itself. In the last 100 years, the stock market has returned only a 2.1% average return during open (no incumbent) presidential election years. Markets historically do well when there is gridlock in Washington, particularly when it’s a Democratic president facing a Republican Congress, like our current situation. This election could very well alter that dynamic.

Furthermore, the debates have featured two parties with radically different visions for the future of America, and while voters might want change, markets are generally fickle to major policy changes and their inherent risks.

The New Year will also be full of economic unknowns. This U.S. economy is not moving at the pace most would hope following a seven-year recovery. Oil is low, inflation is not in sight and the Fed is under a great deal of pressure to begin raising interest rates despite concerns over the strength of the economy.

What does this mean for investors? This atmosphere of uncertainty is likely to create short-term market volatility throughout 2016. And that raises another question: which strategies are best suited to weather a year full of ups and downs? Evidence shows that those who take a long-term, low volatility approach to the markets have reasons to be quite optimistic.

To position a portfolio for a successful year, investors may adjust their thinking from short-term to long-term and look to a strategy with less vulnerability to these mounting economic and political risks. In a climate like this, low volatility strategies are primed to do well.

The coming year will likely be a rollercoaster ride, so investors should buckle up with a plan that’s low-risk and focused on the advantage of future volatility.

David Harden is President and Chief Investment Officer at Summit Global Investments, an SEC registered investment adviser specializing in low volatility investment strategies.

 

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Market Update – December 2012

Season’s Greetings & Merry Christmas!

As this week comes to a close, the markets struggled to find their way amongst the noise in Washington, D.C.  ”Risk on” was one of the themes this week in the U.S. equities markets as we had the two largest back to back increases in the S&P 500 in over 5 months.  ”Risk on” is a term to describe investor money flows into higher Beta, higher Standard Deviation, more volatile names.  For example, If a stock trades at a P/E of 100, investment managers allocating into those names aren’t worried about the volatility these names introduce to portfolios.  Investors start swinging for the fences by allocating into these names.  Their thesis being that these companies will enhance their portfolio returns with faster and higher appreciation vs. other names.  Hence, “risk on”.

The SGI Low Volatility Equity Model seeks to protect investors from experiencing these wild fluctuations, by limiting the downside risk in the portfolio while meaningfully participating in the upside markets historically offer.  On a day to day basis this sometimes is hard to see in the SGI portfolio, especially if the market was up and SGI is down. The return path of the SGI Low Volatility Equity Model will differ from the return path of the S&P 500. Even though the portfolio stays 100% invested in equities the portfolio does not behave in the same manner as the markets.

Since September 14, 2012, the day the S&P 500 peaked for the year the Low Volatility Equity Strategy experience minor drawdowns of around 2%.  At the end of 2012 clients of SGI were essentially flat during this period.  However, the S&P 500 ended the year more than 3% off the highs of September 14, 2012.

For the most recent performance please visit: Morningstar.

Disclaimer: Past returns are no guarantee of future results.  Summit Global Investments U.S. Low Volatility Equity Mutual Fund is sold by prospectus only.

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Market Update – November 2012 (Part 2)

Global uncertainty has created more volatile and linked markets around the world.  Parts of the euro zone have dipped back into a recession, with the Netherlands being particularly hard hit.  Israel and the Palestinian Hamas group are launching rockets at one another with Hamas firing rockets into Tel Aviv & Jerusalem for the first time in over 20 years. Business leaders in the U.S. are applying pressure in a concerted and organized effort to tell Washington to “Rise Above” the politics and avoid the looming “Fiscal Cliff”. One may feel it is all gloom and doom for the markets.  But on the positive side, growth in the US has improved from about 1% to roughly 2.5% over the past few months.  We know that events will always be going on around us causing global uncertainty and volatility.  Some rather serious at times, others just noise.  At SGI we take seriously our role as an investment manager to understand what is happening globally, work through the issues of today that may impact the portfolio and invest accordingly.

A question we are often asked by investors is: “Why don’t you just go to cash when……” This is an important question.  I hope the answer to this question will help you understand the how and why of the way in which SGI actively manages equities.

  • SGI’s portfolio risk is less than the risk of the S&P 500 or the market. Unmanaged baskets of equities (ETF’s) expose investors to the entire risk of the market or of that particular sector.  SGI controls market risk through individual security selection, not by selling into cash or moving in and out of sectors. Whether you measure risk by Std. Deviation or Beta, the SGI portfolio today carries the same risk as having a $100 portfolio with $38 in cash and $62 in equities, yet the portfolio is 100% invested in equities.
  • SGI actively selects the individual equities we own.  By not holding baskets of unmanaged equities we avoid holding names we would not want to own.
  • SGI is not constrained to only owning certain sectors or types of equities, (Large Cap, Growth, Value, Small, Mid, etc.).  This is an important point to understand: SGI will hold stocks with a range of market capitalizations and style of equities.  Our portfolio holds equities across the various size and style metrics.
  • SGI manages to the risk of the market. At times the market shifts into a risk on mode, sometimes risk off, sometimes it is rather directionless.  The SGI Low Volatility Equity Model seeks to position the portfolio to take advantage of where the market is heading.  This is part of the Alpha Model developed specifically for finding specific equities that will exhibit lower volatile characteristics while participating in the upside the markets historically offer and protecting to the downside.
  • SGI offers downside protection by maintaining a fully diversified low volatility equity portfolio.  This allows SGI to stay positioned appropriately when markets experience large up or large down days.  Have you ever left a sporting event early or turned off the game because you felt the game was over? I have on a number of occasions, but I sure wished I had not left some of them early because the comeback was epic.  When the markets make their comeback, SGI will be in the market.

For the most recent performance please visit: Morningstar.

Disclaimer: Past returns are no guarantee of future results.  Summit Global Investments U.S. Low Volatility Equity Mutual Fund is sold by prospectus only.

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Market Update – November 2012

I enjoy riding roller coasters….when I go to Disneyland or an amusement park.  However, I don’t enjoy getting whipsawed down, back and forth by the stock market.  I know you don’t and more importantly, we all know our clients really don’t enjoy it.  What to do?

From a growth and allocation perspective, most investors need real annualized appreciation in their accounts.  Historically, this requires allocating a portion of ones portfolio to the stock market.  At the same time, many investors are uneasy about the volatility the equity market introduces.  Ones reluctance to invest in the equity markets stems from fear of not only losing money but also experiencing large fluctuations in the value of their investments.  No one likes being exposed to the unmanaged equity market roller coaster ride.  Experience has shown that investors either don’t want to get on in the first place, or jump off at the worst possible time.

The SGI Low Volatility Equity Model seeks to significantly reduce the volatility of the equity markets, provide investors with the upside equity markets historically produce, offer superior risk adjusted returns, manage the risk in the market to provide downside protection, all while maintaining 100% exposure to equities. Think of the children’s roller coaster rides at Disneyland.  They still go up and down, but the ride is much smoother.

SGI historically captures around 50% of the markets downside while capturing around 85% of the markets upside*.  This is accomplished through SGI’s proprietary portfolio construction process investing only in individual equities.

A few distinct characteristics of the SGI Low Volatility Equity approach is:

1.  SGI actively selects individual equities in managed accounts and within the Summit Global Investments U.S. Low Volatility Equity mutual fund.

2.  SGI does not attempt to trade in or out of cash or fixed income funds in order to manage volatility.

3.  SGI stays actively 100% invested across individual equities and across all market sectors, managing the risk of the market through individual security selection.

To schedule a call or to arrange for an office meeting to discuss the SGI Low Volatility Equity Model and the portfolio construction process, please contact Bryce Sutton @ 888-251-4847

For the most recent performance please visit: Morningstar.

Disclaimer: *Past returns are no guarantee of future results.  Summit Global Investments U.S. Low Volatility Equity Mutual Fund is sold by prospectus only.

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Market Update – October 2012

Market volatility is back.  Volatility driven by companies reported earnings (Google, Microsoft, GE & McDonald’s missing earnings) and increasing volatility globally whipsawed the markets this week.  Capping off the last full week we saw the S&P 500 dropping -1.66% last Friday.

Over the past few weeks SGI’s continued to receive a number of inquiries regarding how the SGI Low Volatility Equity (LVE) strategy performs during periods when the markets turn negative and/or become increasingly volatile.  As we continue seeing a return to volatility in the U.S. equity markets, it’s important to understand how the SGI LVE portfolio typically* performs.  As markets retreat , historically the SGI LVE portfolio tends to capture around 50% of the downside.  When the market has larger up days, we tend to capture approximately 85% of the upside.  These upside/downside capture ratios always are different from day to day, week to week and month to month.  However, over time this historically is the average. 

As a Firm, SGI is constantly managing to the risk the markets exhibit, seeking superior risk adjusted returns.  The companies in the portfolio are names that exhibit lower volatile characteristics, tend to have strengthening business metrics, higher dividend yields and higher returns on assets vs. the market averages.  These are a few of the characteristics the SGI LVE holdings demonstrate.

For the most recent performance please visit: Morningstar.

Disclaimer: Past returns are no guarantee of future results.  Summit Global Investments U.S. Low Volatility Equity Mutual Fund is sold by prospectus only.

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Market Update – September 2012

The SGI Low Volatility Equity model actively manages individual equities (no ETF’s or funds).  As you are well aware, over the last month the market has seen the return of more upside and downside volatility as evidenced by the daily movement in the S&P 500.  I wanted to share this screen shot from the SGI Low Volatility Equity Model as seen on the Foliofn site.  This screen shot gives you a better idea of how the SGI Low Volatility Equity model performs during these volatile periods compared to the movements of the S&P 500.  You’ll notice that the SGI Low Volatility Equity model is experiencing much smaller drawdowns vs. the S&P 500, while still participating in the upside the markets historically offer.

One of the highest priorities we have as Firm at SGI is to make sure we have an open line of communication with our clients.  Whenever you have questions regarding the SGI investment strategy, please call.

For the most recent performance please visit: Morningstar.

Disclaimer: Past returns are no guarantee of future results.  Summit Global Investments U.S. Low Volatility Equity Mutual Fund is sold by prospectus only.

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Market Update – August 2012 Six Month Review

The second quarter of 2012 began with U.S. equities continuing to give back some of the gains achieved earlier in the calendar year. In the days leading up to August 31, 2012, markets continued to be shaken by European debt issues and by U.S. economic data. Monetary policy and fiscal policy have also come front and center as the debates continue over the ultimate success of quantitative easing and U.S. election outcomes. The resulting global uncertainty has created more volatile and linked markets around the world.

As we consider recent events and ponder what may lay ahead, we know with more clarity that world events certainly affect the U.S. markets. We do not stand alone, isolated from the world. U.S. companies are global companies. Their revenue and sales, business plans and investment and ultimately success or failure are more correlated to global events than ever in history. As such, we must keep an eye on such events throughout the coming months and years.

In addition to these global and political drivers, companies are unique in how each prepares, responds and survives the impact of world events and economic cycles. While some cycles may vary in length and events differ in impact, we believe, for U.S. equity exposure, the Summit Global Investments U.S. Low Volatility Equity Fund (the “Fund”) approach is effective over full market cycles.

Our philosophy to navigate such markets is simple and consistent throughout up and down markets. We believe that being invested in a low volatility equity portfolio over full market cycles provides lower price fluctuations, more consistent and reliable returns with smaller drawdowns and adds increased diversification when combined with other investment strategies. Our approach takes into account each underlying company’s stock volatility, expected market return and how it correlates with other stocks within the portfolio, ultimately seeking to maximize return with an overall lower risk than the cap-weighted benchmark.

As stated in the prospectus, the Fund seeks to outperform the S&P 500® Index over a market cycle while reducing overall volatility or risk.

The Mutual Fund’s (SILVX) shares rose 1.80% for the period February 29, 2012 (inception) through August 31, 2012 and rose 5.27% for the quarter ended August 31, 2012.  While the Fund lagged the S&P 500® Index on an absolute return basis, on a risk-adjusted basis the strategy performed well: 5.27% for the Fund vs. 4.93% for the S&P 500® Index (7.93% multiplied by the beta of the Fund, 0.62) for the quarter ended August 31, 2012.

Financial markets are always unpredictable but there are several time-tested investment principles that may help put the odds in your favor. We firmly believe that investing with a long-term, risk-return perspective is key to experiencing superior risk-adjusted returns. While staying the course with a low volatility portfolio doesn’t eliminate risk, it can considerably lessen the effect of market volatility. While we are optimistic about the opportunities within the U.S. equity market, we remain laser focused on monitoring the risk of individual companies and the overall portfolio. During these times of uncertainty and volatility, we believe, for U.S. equity exposure, the Summit Global Investments U.S. Low Volatility Equity Fund approach is warranted.

For the most recent performance please visit: Morningstar.

Disclaimer: Past returns are no guarantee of future results.  Summit Global Investments U.S. Low Volatility Equity Mutual Fund is sold by prospectus only.

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Market Update – May 2012

For May stocks fell in a straight trajectory and the VIX, a measure of volatility, increased over 40% to end the month at 24.06.  The first half of the month was driven by concerns over Europe.  But towards the end of the month U.S. economic data provided increasing evidence that the recovery may not be taking hold.  The 10-year Treasury note established a new all-time low of 1.59%.  As a whole, the SPX for the month ended down -6.01%.

The U.S. Low Volatility Strategy was also down -0.39%* thus out-performing the index by 5.62% for May.  One a risk adjusted basis the U.S. Low Volatility Strategy out-performance was 8.25%.  This is yet another example of how our Low Volatility Strategy protects against the downside.  Even the Barclays Global Aggregate Index, which represents global bond markets, declined by -1.03%.

May*
Low Volatility Strategy -0.39%
S&P 500 Index -6.01%
Relative Return 5.62%

 

The investment objective of the SGI U.S. Low Volatility Equity Strategy is to out-perform the SPX with less downside risk over a full market cycle.  To achieve this investment objective, the portfolio invests in U.S. equities that historically demonstrate low volatility characteristics and meet our proprietary algorithms and criteria.  We know return paths vary over periods of time, which is why we take a long-term approach seeking equity type returns with much less volatile stocks.

Market Update

The markets quickly went south as economic data in Europe painted a very poor picture.  Couple this data with a political stalemate with Greek elections and continued disagreement between European nations on terms/measures for a bailout you have a clear direction – a straight down market.

US economic data did not help matters as Q1 GDP estimates were revised lower to 1.9% suggesting slower growth than previously predicted.  U.S. Consumer Confidence fell more than expected to 64.9 and the labor market provided more fuel to the downward spiral of growth prospects with the unemployment rate ticking up to 8.2%.

Keep everyone guessing manufacturing data beat expectations, and retail sales showed that consumer spending had slightly increased between March and April.

Again we ask the question how will Europe navigate the crisis?  As they say, “The devil is in the details”.

Keep an eye on the Federal Reserve as many are hoping for ‘uncle Ben’ to bail them out.  Also, U.S. economic data are still relevant and could prove to move the U.S. market.

* GIPS aggregate performance
Summit Global Investments does not render legal or tax advice, and the information contained in this communication should not be regarded as such.  Prospective investors will be given the opportunity to further discuss the model and such data.  Past performance is no guarantee of future results.
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Market Update – April 2012

For April stocks skidded and volatility appeared throughout the month.  Volumes increased and the VIX, a measure of volatility, ended the month at 17.15, still below average (though the last week of the month saw an uptick in price which is inversely related to the VIX) but a hint of increased volatility nevertheless prevailed.  As a whole, the SPX for the month ended down -0.63%.

The U.S. Low Volatility Strategy returned 1.07%* thus out-performing the index by 1.70% for April.  One a risk adjusted basis the U.S. Low Volatility Strategy out-performance was 2.09%.

April*
Low Volatility Strategy 1.07%
S&P 500 Index -0.63%
Relative Return 1.70%

 

The investment objective of the SGI U.S. Low Volatility Equity Strategy is to out-perform the SPX with less downside risk over a full market cycle.  To achieve this investment objective, the portfolio invests in U.S. equities that historically demonstrate low volatility characteristics and meet our proprietary algorithms and criteria.  We know return paths vary over periods of time, which is why we take a long-term approach seeking equity type returns with much less volatile stocks.

Market Update – “Will Q2 of 2012 look like 2011?”

The markets trailed off as poor economic data and renewed worries about Europe prevailed.  Two negative regional manufacturing surveys were a drag on the market: the April Dallas Fed index widely missed expectations and the Chicago Purchasing managers’ index hit its lowest level since November 2009.  In Europe, Spain followed the UK into official recession territory and bailout fears and anti-austerity resurfaced.

Vibrations from Europe are reaching the U.S. market.  Multinational companies are not immune.  How will Europe navigate the crisis, not whether they will, is right the question to be asking?  Surely Europe will have to deal with the crisis.

The U.S. political campaigns and outcomes have seem to fallen a sleep for now.  Hopefully they do not wake up on the wrong side of the bed.  Keep an eye on the Federal Reserve and U.S. economic data for indications the most recent negative data spreads or continues.  If so, the Fed may be forced to act and Q2 2012 will look increasingly like 2011.

* GIPS aggregate performance
Summit Global Investments does not render legal or tax advice, and the information contained in this communication should not be regarded as such.  Prospective investors will be given the opportunity to further discuss the model and such data.  Past performance is no guarantee of future results.
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