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Change of Seasons Quarterly Report | 3rd Quarter 2014

The purpose of this quarterly update is to help guide our current and prospective clients regarding the design, purpose and results of our various investment strategies. We strive to offer complete transparency throughout our business in hopes that our clients will be empowered by knowledge to participate in the strategic allocation of their investment portfolio. Please enjoy my personal insights below.

NEW* - Explicit Investing Creed of ASFA:


We are seeking Success over a reasonable Judgment Period by knowing when to embrace and reject conventional wisdom regarding perceived market trends, Risk and opportunities. Superior, above average, results over time are only achievable through unconventional decision-making, conviction, and discipline.


Risk (defn.)– The probability of unrecoverable or semi-permanent loss of capital, not to be confused with variable degrees of periodic volatility.


Success (defn.) – Generating asymmetrical results across all investment strategies: to expose ourselves to return in a way that doesn’t expose us commensurately to risk, and to participate in gains when the market rises to a greater extent than we participate in losses when it falls.


Judgment Period (defn.) – A period of time that captures a full investing cycle including both bull and bear markets – typically any rolling 5-6 year period.

Our Strategies

Just below the title of each strategy, there is a link to the details page on our website in PDF format which offers a new and absurdly analytical view of each strategy; including risk metrics, risk/ return charts, beta and correlation measures and all the stuff that techy people love.  Complete performance history of each strategy as well as relevant benchmarks can be found by following the link provided “Details”.   Each of our clients will have a different experience with us depending on one’s particular mix of strategies chosen and the amount of money invested in each.  Very soon, we will be launching our web based investor profile tool to help guide our client’s in allocating among our strategies from each of our three categories (Tactical Equity, Blended Asset and Income).  Ultimately, we hope to create an appropriate mix that satisfies our client’s appetite for returns and tolerance of portfolio volatility

Strategy insights are presented within their respective categories of investment;  Tactical Equity, Blended Asset and Income.  All results are shown as 2014 year to date returns ending September 30, 2014, net of all fees.

Tactical Equity Strategies

High Dividend     3.73%  YTD

  High Dividend Strategy Details


High Dividend has made very few changes to internal holdings all year, remaining almost fully invested through the up and down cycles of 2014.  Given the increase in selling pressure in September and now carrying into October, manager Sean Powers has his upgrade list in front of him and is waiting to strategically replace some weaker holdings with those that are positioned to benefit from the new investing environment (rising US dollar, tighter financial conditions, less support from the Fed).  Typically, during bull market cycles, High Dividend focuses more on company fundamentals and valuations above short-term price trends.  One of the main challenges of any dividend strategy is to remain largely invested and purposely carry little in the way of cash as dividends can only b paid on shares of company stock.  Of course, money markets are paying nothing so we have an inherent interest in owning lots of shares for as long as possible to generate real dividend income.  The trick from a risk management perspective is to own the right stocks and the right mix of stocks seeking a portfolio of non-correlated holdings whenever possible.  Sean has done an admirable job sticking to his discipline through a tough market this year.  Periodic gains (and recent losses) are of the type I would expect in this market; not better, nor worse.  Like our other tactical equity strategies, we are not expecting much in the way of strong performance for calendar year 2014 as global stock markets take a rest and let earnings catch up to the incredible price gains made in 2013.  If conditions continue to deteriorate and a real bear market becomes more likely, High Dividend will take meaningful steps to cut total exposure and orient toward more defensive holdings to stay consistent with our "Explicit Investing Creed" (LINK).  For now, we grind our teeth, take a few antacids and give this bull market the benefit of the doubt.  2014 is not going to be a big year for any stock model as we've discussed at length.  But, a nice pause that refreshes could set us up nicely for a more sustainable move higher in 2015 and beyond.

Still relevant comments from the beginning of the year (2014) - 

"A smart dividend paying stock strategy is one of the most attractive ways to make consistently strong returns with a lower embedded risk profile.   Logically, it’s hard to beat the combination of dividend income plus capital appreciation as an investment choice for investors who value a relatively conservative stock model.  Furthermore, from a cyclical perspective, companies with growing dividends inherently have several characteristics that investors find very attractive now.  Specifically, these companies tend to have higher free cash flow and lower debt to equity, making them less subject to the risk of higher interest rates (higher borrowing costs).  Second, dividend growing companies are often engaging in share buy back programs which has the effect of reducing the total number of shares outstanding, thereby supporting the current stock price.  Effectively share buy backs give companies more control over their own finances.  Finally, companies that offer dividends are now competing for bond money that is looking for a new home.  A portfolio of stocks paying 3.5% in dividend income is paying more than the 10-year Treasury bond interest rate!  Three great reasons to fundamentally invest in High Dividend."  This strategy is and will continue to be a winner.


Worldwide Sectors     3.02% YTD

 Worldwide Sectors Strategy Details 


For those paying attention to these insights, you might recall our attempt to rebuild a position in emerging market funds within the Worldwide Sectors strategy last quarter.  Unfortunately, by the end of the same quarter four of our five international positions were already stopped out leaving us with only a small position in India (EPI).  These are called whipsaw trades and I hate them as much as anyone.  No one expected the US dollar to rise nearly 7% in one month creating all sorts of carnage among internationals, raw materials, energy and commodity groups.  We will be back into emerging market funds in 2015, I'm quite sure.  The fundamental and value oriented environment for re-investment in developing countries is already ripe, but technical price trends always dictate our holdings and right now, the tide is still going out.  Our cash position in Worldwide Sectors actually pushed up to nearly 20% in the process.  Beyond an oversized cash position, we still have a nice blend of growth and value oriented stocks and stock ETFs in the strategy that should (knock, knock) hold the strategy together while the broad US market completes this correction.  Those invested in Worldwide Sectors need to understand that this program is one of the most volatile and exposed strategies.  In rising markets, volatility is very much your friend.  In falling markets, you can expect to see some periodic losses.  Over time, Worldwide Sectors is the strategy that will produce results most consistent with any of the broad US stock market indices although with greater downside risk controls and generally higher dividend interest income.

Worldwide Sectors is also a member of our STAMP team.  STAMP is an acronym for Strategic Tax Advantaged Management Portfolios.  Tax efficiency is found by way of generating long term capital gains whenever possible, taxed at lower rates (20%) than income (35%+). For high-income earners in higher marginal tax brackets, long-term capital gains taxes are still a distinct rate advantage.


New Power     -1.83%   YTD

 New Power Strategy Details

My comment from the 2nd Quarter, 2014, is still very relevant, "New Power could easily see a bit of a consolidation year following the 60% gains of 2013.  No surprise right now so, please set your expectations accordingly.  I have no crystal ball but big years are not typically followed by more big years."

New Power has slipped into marginally negative territory YTD as of the end of September.  Like several of our other strategies, many of the positions in New Power were stopped out in August and September leaving us with almost 50% cash and only ten positions left in the portfolio.  Strangely, only two of them are in the energy sector, which might sound odd for a strategy called New POWER.  In early 2013, the scope of the investment options was expanded to include opportunities in non-energy industries.  These additional holdings fall into one of three camps; Innovators, Facilitators and Integrators.  All of which are game changers in their space.  Since the entire energy complex entered a bear market (down 20%+) in the middle of September, I am suddenly quite thankful for the flexibility to go elsewhere.  Clean energy and clean technologies are still going to be a large part of New Power, just not at the moment.  Those willing to be patient will see handsome returns but they will come in short bursts.  Our next series of actions will be buys and we're already making a short list.  For any interested in New Power, conditions are becoming more attractive for new investors in this strategy.  No rush, but I think we're getting close.  

Blended Asset Strategies

All Season      3.12% YTD

All Season Strategy Details

Wow, what a difference one quarter can make.  The 3rd quarter was brutal for all asset allocation models.  On July 1st, the financial world turned upside down forcing us to make more changes in All Season than we anticipated.  Europe turned back toward recession with Germany leading lower and the Euro fell apart driving the US dollar higher.  All internationals and any company generating revenue outside of the US (nearly 60% of the S&P 500 companies) saw real selling pressure.  Commodities of all sorts fell off a cliff and the energy complex entered a bear market.  Our remaining income positions that weren’t sold back in July fared well and we still own them.  Most of our “alternative” positions were sold as several hit stops and our equity positions had to be upgraded almost across the board to accommodate new leadership.  Ugly, tiresome and thus far we have little to show beyond knowing that we are now better aligned with market trends.  This is the nature of investing and this is the work we must all endure.  Returns come with correct market alignment, especially those that are earned without experiencing intolerable declines.  Sometimes we can just sit back and collect our returns, other times we work hard just for the right to collect in the future.  This is one of those times.   

As one of our most flexible investment strategies, I have no doubt that All Season will generate respectable results as it has done since inception in 1998!  The strategy never has and never will surprise you will huge gains or huge losses.  It will however, produce stable and consistent returns over time and keep your money in the right market, the right sectors, and the right asset classes as conditions change.


Foundations   3.13% YTD  

Foundations Strategy Details

Foundations has also been sitting with an abnormally high cash position (25%) following the sale of most bond holdings in mid July.  As a more traditional asset allocation model, we tend to remain invested across multiple asset classes but the current market situation calls for a little more dynamic approach.  Following the same protocol as All Season, our Foundations model has also had to make several trades in the last quarter to better align the portfolio with current trends in leadership including sector rotations as well as repatriating some of our international exposure.  Exposure to stocks has remained largely the same through the process and that has hurt returns a bit.  Nevertheless, if this bull market in stocks is still alive, we'll be positioned well and make it back quickly.  If a new bear market is upon us, we'll have to play some stronger defense in the coming months.

Foundations is our lowest cost strategy designed for investors with smaller accounts (<$100k). It offers a more dynamic approach than your traditional buy and hold strategy, which is miraculously still prevalent in our industry.  I do wonder what will happen when investors begin to see their "balanced" fund chain itself to a 3-4% annual return as their oversized bond allocations begin to lose money year over year.  I can already see the headlines, "Is it time to get out of your Balanced Fund?"  Foundations is a great alternative, keep it in mind.

Gain Keeper (previously known as Annuity Sectors)   3.27%

Gain Keeper Strategy Details

Gain Keeper followed its Blended Asset category peers in rotating into more defensive sectors and specifically those not exposed to the negative impacts of a rising US dollar.  Predominantly, that meant selling out of international and energy positions this quarter and replacing with Utilities, consumer staples and a small position in banking.  Bond allocations, like our other strategies are still snugly sitting in cash.  We are shifting our prescribed allocations a bit toward stocks and willing to carry as much as 75% in stocks under the right conditions. On the other side of this correction, perhaps closer to the time the Federal Reserve finally raising short term interest rates (April?), we’ll have a strong arm ready to swing the bat at cheap stock prices.   Gains in 2014 are going to be muted as we have discussed at length in all communications (See – “Transition Year” discussions on the Red Sky Report).   

As a reminder regarding this Variable annuity, I want to keep the facts of this program out in the open for all to digest to help understand the circumstances under which an investor might find a variable annuity appealing.  We find the annuity attractive for our clients who have recently divorced, inherited money, sold a business or have larger taxable accounts simply by circumstance, especially with the new higher income tax rates!  Variable annuities are one the very few ways to shelter a great deal of after-tax money from future capital gains and income taxes without being subject to contribution limits, (like an IRA or qualified retirement plan).  Growth of investment assets in tax deferred accounts is hard to beat relative to taxable investment as investors only pay tax on withdrawals when they happen after years of tax deferred accumulation. Jefferson Annuity charges a very low $20/ month for virtually unlimited tax deferral of investments.  The rules regarding penalties for early withdrawals before age 59.5 are the same as an IRA (10% + Income tax), but there aren’t any annual contribution limits.  

Gain Keeper is a member of our STAMP team of strategies.

Income Strategies

Retirement Income             2.99% YTD

Retirement Income Strategy Details

The main investing tools behind Retirement Income are High Yield corporate bonds and as of the end of Q3, we don’t own any.  We sold nearly all in mid July following our sell discipline and now sit with only a few preferred securities, a diversified income fund and a pile of cash.  Thus far, any attempt by high yield corporate bonds to push higher has been met with significant selling pressure taking prices back to new lows.  However, in recent weeks, especially in October, we have seen corporate bond yields move dramatically higher, while comparative 10 year Treasury bond yields fell to new lows (2.0%).

Our discipline closely watches this comparative “spread” and it’s starting to look very attractive again!  I’m expecting to re-engage with High Yield corporate bonds soon if the price trends give us confirmation.  Other “equity income” type securities are available outside of corporate bonds for potential inclusion in Retirement Income but most have far too much daily and weekly volatility now to be considered.  Treasury bonds are still unattractive. Cash is earning zero and we don’t relish the idea of offering you nothing in the way of returns.  Know that we are committed to making money but also know that we will do so only when the time is right.
Retirement Income is designed for retirement accounts as the name implies.

Freeway High Income     4.17% YTD

Freeway High Income Strategy Details

Freeway High Income was one of the bright spots in the 3rd quarter, producing positive results and rising fast in the face of the stock market drama.  Like Retirement Income, Freeway has not yet reengaged with our corporate bond investments.  However, the strategy has been able to hold onto its overweight position in high yield municipal bonds earning ~5% Federal Tax fee interest plus another 11% in annualized price appreciation.  Of course, that’s an unsustainable return for municipal bonds and I have little doubt we’ll be taking profits soon in this asset class.  But for now, we’re enjoying the ride.  As mentioned in several communication pieces as well as our annual meeting presentation last week, we expect our Income model returns to taper a bit from a long-standing 7-8% down to roughly 5% as an average annual.  This condition should last for another year or two while interest rates reset higher.  At this point, 5% is starting to look pretty good!

The strategy is designed to produce results that are materially very close to our long-standing Retirement Income approach but after tax returns should be more attractive especially for those in higher income tax brackets with higher marginal tax rates.  Freeway High Income is a member of our STAMP team.

That’s it for this quarterly "Change of Seasons" newsletter.  These are our insights and self-critical observations of our own work for your benefit and understanding.  We hope you find this helpful.  Thank you for your confidence in our management service, we appreciate your business  - always.


Sam Jones
All Season Financial Advisors, Inc.