Back to Frontier Insights,Market Commentaries

Monthly Perspective | May 2019

17 May 2019

Geremy van Arkel, CFA® | Principal

Millimeters Matter

Several years ago, I made a conscious decision to get serious about cycling. After years as an avid cyclist, I had reached a plateau in my performance – a limit to what a recreational cyclist could achieve on gumption alone. I decided it was time to take my game to the next level. However, I soon found out that achieving meaningful gains in performance would require much more than a change of heart or simply upping my training. In cycling – much like in most other challenging endeavors – in order to go from average performance and mediocre results to something significantly better, there is never any one, single action, but a whole process. Cycling success is the result of several factors. The main components needed are exercise, diet, rest, and tactics. Without dedication to a step-by-step process in which each of the four play an important role, no breakthrough will be made.

First, though, any cyclist wanting to up their game needs to have their bike professionally fitted. Surprisingly, my younger self had never even considered this step – after all: what difference could a few little tweaks to my bicycle make? After three hours of riding a computerized bike while hooked up to power meters monitoring my form while I was filmed, I realized I had been missing the main point of performance advancement. After all was said and done, and many tiny adjustments made to my bike, riding position, and form, I began to see the greatest performance gains I had ever achieved. I profusely thanked the bike fitter, a local legend. “Millimeters matter,” was his reply. And oh, how true that is.

To get serious about consistent investment performance is to get serious about process. And to get serious about process is to get serious about details and accuracy. Frontier’s investment process is comprised of four different sub-processes: mutual fund selection, asset allocation, strategy optimization, and trading and implementation. Each one of these processes is like a manufacturing line, where a multitude of steps, calculations, and decisions are being made each month. There are quite literally thousands of formulas that make up these processes. Change one formula, and you get a different result. Alter the steps, you could have a different outcome. It is all details and accuracy, a thousand times over.

It is worth noting here that simply having a process is not enough, but that everything within that process needs to move the action in the right direction. Frontier is not your average pie chart firm. Asset allocation is part of our overall process, but the quest for the “perfect” pie chart is not the goal of our process. There is no such thing as a perfect pie chart or a mythical combination of assets that will solve all of the client’s needs, all of the time. Nor will a pie chart alone save you. In our modern, interconnected marketplace, when markets turn south, assets become correlated in a hurry. Instead, Frontier’s investment process is outcome driven. The whole point of our process – and of every decision we make and formula we develop – is to provide a better result for our clients. This means less potential exposure to loss, a greater potential for growth, more consistent return patterns, lower taxes, and a strategy that that is easy to live with.

Similarly, any effective process needs to focus on variables that can be measured and directly lead to outcomes. In other words, control what you can control. Much of the outcome investors will experience year-to-year is out of our control. We simply cannot control capital markets, and no one has perfect future knowledge.

Much of the investment world is seeking to outperform when capital markets performance is good. However, short-term return is the most unknowable variable in an investment process.  Ubiquitously, the industry looks to economic data, market technical data, or politics in an effort to predict short-term capital market performance. But this approach is merely “truthy”. It sounds right, it feels right, but there is no solid link between these factors and short-term market performance. It should be considered a financial law that capital markets lead the economy, not the other way around. If you want to make a prediction about the economy, look to capital markets. If asset prices are rising, chances are the economy is improving. However, if you reverse that equation and want to know how capital markets will perform, looking to the economy will yield random results, at best. As they say, the hall of fame of market timers is an empty room.

The focus of Frontier’s processes is based on variables that we can measure and or control.  Some of the more known or measurable variables we focus on include long-term capital markets expected returns, potential downside, mutual fund added value, mutual fund expenses, mutual fund combinations, taxes, and trading efficiencies. By focusing on these variables, we are better able to construct strategies for specific risk levels that perform well through a multitude of environments – not just the positive outcomes – and to be able to provide consistent mutual fund added value and to manage taxesThis focus has enabled Frontier clients to better withstand poor market environments and to achieve more consistent overall performance through the multitude of market environments that inevitably unfold.

Don’t be fooled to think that we – or anybody else, for that matter – have this whole thing figured out. There is no such thing as a perfect process. Everything can, and needs to, be constantly tested and continuously improved. We at Frontier are currently further refining our mutual fund selection process, working on improving our earnings methodology in our equity expected return models, and seeking to improve efficiency of our tax management trading. All of these improvements involve testing logical concepts, turning them into math, and testing results through time in search of beneficial measurable outcomes. When you think big, but focus on details and accuracy, there is no end to the improvements you can achieve.

In the investment world, it is easy to think that performance is attributable to a salted guru making big bets that produce big wins. In reality, though, achieving consistent performance that survives a multitude of market environments requires running logical, effective processes over and over again. Performance is achieved on a tiny scale, from an accumulation of hundreds of decisions. The investment process itself either inches forward, one millimeter at a time, or its destiny is death by paper cuts. Every investment company faces this reality, whether they admit it or not.

In cycling, performance is easy to measure precisely, and progress – or lack thereof – is simple enough to track. Races are won with tight margins, often by millimeters, but the winner can still always be declared. In the world of investment, measuring performance and declaring a win or a loss is not that simple. Why? Because there isn’t just one parameter to define success but several, and the potential benefits that clients can achieve are multi-dimensional. Clients need risk management, growth in wealth, consistency of returns, tax management, and livability – not just one of these factors, but all of them. And while it is possible to improve the clients’ outcomes in all of the areas mentioned, it is often only by a small margin which can at times be hard to measure.  Yet when these constant small wins and minor outcome improvements are weaved together and accumulated over a long period of time, they can result in meaningful improved performance with great impact and significance. Millimeters matter.

April 2019 Strategy Review

By Gary A. Miller, CFA

 

April 2019 saw a continuation of 2019’s first quarter stocks rally. The Wilshire 5000 Index of US stocks returned approximately 4% while the MSCI All Country World Index ex-US gained a little over 2.6%. By the end of the month, both indices had erased all of their fourth quarter 2018 losses. Bonds did not fare as well in April, as their negative correlation to stocks played out as we expect. The bondiest bonds, long-term Treasuries, lost nearly 1.8% in the month, according to the Bloomberg Barclays Index. However,  for the entire seven month down-market up-market cycle, the index returned a little over 7%, which is impressive.

 

Frontier’s Globally Diversified strategies also posted strong positive returns in April, which once again was pretty easy considering how well the markets performed. The equity dominated strategies, Balanced through Global Opportunities, trailed their Globally Diversified benchmarks modestly. At the same time bond dominated strategies; Capital Preservation, Conservative, and Multi-Asset Income outperformed modestly. Both sets of strategies outperformed for the same reason: they are positioned conservatively because equity prices are relatively high. Therefore, return expectations of equities are lower than we would like, and interest rates are low, so fixed income expected returns are also lower than we would like. Since stocks were up, being conservative hurt the performance of the equity dominated strategies and since bonds were down, being conservative helped the performance of the bond dominated strategies. As is often the case, the fund managers as a group added value above index funds in April. This helped close the gap between the equity-dominated strategies’ performance and their benchmarks and pushed the bond-dominated strategies’ performance further ahead of theirs. Fund added value has been so good thus far in 2019 that when reviewing the performance of the Globally Diversified strategies year-to-date it is hard to guess we have been positioned conservatively. Longer-term performance across strategies and across time-periods continues to be better than benchmark with few exceptions.

 

Frontier Asset Management’s unconstrained Alternative Strategies were also up in April and up more than hedge funds, according to the HFRX hedge fund indices. Focused Opportunities once again trailed its stated benchmark, the S&P 500®, by a noticeable amount since the S&P 500® continues to be the top-performing major index and has no risk controls built in. However, the performance of Absolute Return, Absolute Return Plus, and Focused Opportunities is perfectly aligned when viewed in a return for risk framework. Performance of the alternatives strategies continues to look favorable relative to the hedge fund universe and alternative strategies available in mutual fund formats.


Past performance is no guarantee of future returns.  Performance discussed represents total returns that include income, realized and unrealized gains and losses. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any types of securities and no investment decision should be made based solely on information provided herein. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for an investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. All performance results should be considered in light of the market and economic conditions that prevailed at the time those results were generated. Before investing, consider investment objectives, risks, fees and expenses. All calculations of performance are by Frontier.
Information provided herein reflects Frontier’s views as of the date of this newsletter and can change at any time without notice.  Frontier obtained some of the information provided herein from third party sources believed to be reliable, but it is not guaranteed, and Frontier does not warrant or guarantee the accuracy or completeness of such information. The use of such sources does not constitute an endorsement. Data sources for funds and indices are Morningstar, the Hedge Fund Research Institute and BarclayHedge. Other sources include: National Geographic.
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance.  References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries or financial instruments of any kind.  This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment or tax advice.
Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision.
Hypothetical expected returns have certain limitations, are shown for illustrative purposes only and it should not be assumed that actual results will match the hypothetical expected returns shown. Unlike actual performance, hypothetical expected returns do not represent actual trading and since trades have not been executed, the results shown may have under or over compensated for the impact, if any, of certain unforeseen market factors. Hypothetical expected returns, whether back-tested or forecasted, have many inherent limitations and no representation is being made that any account will or is likely to achieve the results shown. In fact, there are frequently material differences between hypothetical expected results and actual results achieved. One of the limitations of hypothetical expected results is that they do not take into account that material market factors may have impacted the adviser’s decision making process if the firm were actually trading clients’ accounts.  Also, when calculating the hypothetical expected returns, the adviser has the ability to change certain assumptions and criteria in order to reflect better returns. There are numerous other factors related to the markets in general or to the implementation of any specific investment strategy that cannot be fully accounted for in the preparation of hypothetical expected results, all of which can adversely affect actual trading and performance. Importantly, it should not be assumed that investors who actually invest in this strategy will have positive returns, or returns that equal either the hypothetical expected results reflected or any corresponding benchmark presented.  In addition, performance can, and does, vary between individuals.
In reviewing the performance information presented here, we recommend that you consider both the returns generated and the level of risk that was assumed in generating those results. We believe that performance information cannot be properly assessed without understanding the amount of risk that was taken in delivering that performance. The performance information presented here covers different time periods. We present performance information for short time periods because we understand that clients and potential Investors are interested in this information, however, we recommend against making any investment decisions based on short-term performance information. For any investment products mentioned herein, a complete description of their investment objectives, along with details of the risks and fees involved is contained in their respective prospectus and statement of additional information, which is available on their websites and should be read fully.
It is generally not possible to invest directly in an index*. Exposure to an asset class or trading strategy or other category represented by an index is only available through third party investable instruments (if any) based on that index.
INDEX
INDEX DESCRIPTION
S&P 500®
Represents US large company stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, AMEX, and NASDAQ
MSCI All Ciuntry Index ex-US
The MSCI ACWI ex-USA is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI ex-USA consists of 44 country indices comprising 23 developed and 21 emerging market country indices.
Barclays Capital Long U.S. Treasury
Includes all publicly issued, U.S. Treasury securities that have a remaining maturity of 10 or more years, are rated investment grade, and have $250 million or more of outstanding face value
Benchmark Composition. The Benchmarks for the Long-Term Growth, Growth & Income, Balanced, Conservative and Capital Preservation strategies are combinations of the Wilshire 5000 Total Market Index, MSCI All Country World ex US Index, Bloomberg Commodity Index, HFRX Global HF Index, Barclays US Aggregate Bond Index and 3-Month T-Bills.
The blends of the indices are currently:
Capital Preservation Bench
Conservative Bench
Balanced Bench
Growth & Income Bench
Long-Term Growth Bench
Wilshire 5000
10%
15%
30%
45%
50%
MSCI AC World ex US
0%
5%
15%
20%
30%
Bloomberg Commodity
15%
15%
10%
10%
10%
HFRX Global HF
25%
25%
20%
15%
10%
Barclays US Agg
40%
40%
25%
10%
0%
3M T-Bills
10%
0%
0%
0%
0%
Benchmarks for the Global Opportunities, Focused Opportunities, Absolute Return Plus, Absolute Return and Short-Term Reserve strategies are the MSCI World, S&P500®, HFRX Global HF, HFRX Absolute Return and Barclays Capital 1-5 Year US Treasury Indices, respectively. In the case of indices that include foreign securities, index returns are still presented on a total return basis but will be net of foreign taxes on income generated by these securities.
Frontier’s ADV Brochure is available at no charge by request at info@frontierasset.com or 307.673.5675.
051419CST123119

Frontier Insights,Market Commentaries

Gary’s Thoughts, Geremy’s Thoughts, Today's Markets