Active Construction in a World of Active Investing

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Created October 5, 2016 and last updated July 7, 2017 (In progress & constantly updated)

The Case for Active Portfolio Construction

ESPN Monday Night Football ("Fail Mary")

Green Bay Packers (1-2) @ Seattle Seahawks (2-1) September 24, 2012 On the final play of the tightly-contested game, rookie Seattle quarterback Russell Wilson threw a Hail Mary pass into the end zone intended for wide receiver Golden Tate. Both Tate and Packers defender M. D. Jennings got their hands on the ball while both players were still in the air and attempting to gain possession. The two officials near the play initially gave separate signals of touchdown and touchback, before ruling the players had simultaneous possession, resulting in a Seahawks game-winning touchdown. Prior to the catch, Tate shoved Packers cornerback Sam Shields with both hands, which the NFL later acknowledged should have drawn an offensive pass interference penalty that would have negated the touchdown and resulted in a Packers victory. The lack of a pass interference penalty and the ruling of a touchdown via simultaneous catch were widely questioned in the aftermath of the game, drawing comments from the game's announcers, NFL players, and the media. The NFL subsequently released a statement defending the touchdown ruling. Source: Wikipedia

Fail Mary (2012 NFL Edition)

Did We Dodge Fail Mary 2016?

The S&P 500 from 1994. The market had 4 minor corrections leading into the Election.

The Federal Reserve

R.I.P. Charles Schultz

In November 2008, Chairman Ben Bernanke led the Federal Reserve to initiate Quantitative Easing or "QE" by purchasing $600 billion in mortgage-backed securities. Earlier, in the Spring, Bear Stearns was taken over by J.P. Morgan for $2 per share. In September, Fannie Mae and Freddie Mac were seized by the U.S. Government. Lehman Brothers filed for bankruptcy on the same day that Merrill Lynch was taken over by Bank of America. And then AIG got bailed out the following day. We know now that the Government orchestrated TARP to hide Citigroup's near collapse.

The famous "Helicopter Money" speech was Ben Bernanke's first public speech as Fed Governor.

Ben Bernanke Speech, Deflation: Making Sure "It" Doesn't Happen Here

Economic Historians will determine whether the Fed erred by extending Quantitative Easing

I think it is funny to compare the market's collective angst to that of Spider-Sense (Spider-Man's "spider-sense" manifests in a tingling feeling at the base of his skull, alerting him to personal danger in proportion to the severity of that danger. Source: Wikipedia)

The Big Picture

This is a 50+ year chart of the 10-Year Treasury Rate and the variables that have influenced its secular decline. Four different Fed Chairs, including Paul Volcker, Alan Greenspan, Ben Bernanke and Janet Yellen. Since Volcker, the 10-Year Yield has been crushed. The 10-Year is a good proxy for risk-free interest rates that can be earned by Investors.

Investors Need to Generate Positive Investment Returns in This Low Return Environment

Prior to the Great Recession, an American saver earned approximately $5,000 in Interest Income for every $100,000 saved. (Chart last updated May 8, 2017)

PORTFOLIO CONSTRUCTION IS CRITICAL

"Fail to plan, and plan to fail"

R-Squared Is The Enemy

The Plan is to minimize R-Squared

*R-Squared* is a statistical measure which shows how closely a Mutual Fund's investment performance tracks its portfolio benchmark. R-Square is expressed in a range of (0 to 100) with 100% indicating perfect correlation to the benchmark. In the mutual fund in Exhibit A is long-only.

Mutual funds tend to exhibit high R-Squared to the S&P 500 due to similar holdings composition ("shadow" or "closet" indexing). In some cases, large institutional investors will seek Funds with high proven R-Squared statistics.

Do you want a fund with a High R-Squared to the S&P 500?

In the Meridian Equity Income Fund, Portfolio Construction designed to compound capital gains while minimizing large draw downs

In Exhibit C "Financial Crisis" means a 30% correction to the S&P 500. In this example: (1) Cash position of 10% does not lose value (2) Gold position should hold its value, perhaps it could double (3) By definition, all of the single stock short positions should "work." By design, Meridian Equity Income Fund has similar (or more) tracking error to Exhibit A in up markets while having significantly less risk in down markets.