HCM Management Strategy

We strongly believe that Risk Management strategies should be at least a part of every investor’s portfolio.  Since according to Ned Davis Research, Bear Markets in the last century (defined as a decline of -20% or more by the S&P 500 lasting more than 3 months) lost -31% on average (and the Lipper Large Cap Growth fund Index fell –64% in Bear period of 3/31/00 through 3/31/03), we are confident that, if given a choice, no investor would intentionally keep their portfolio fully invested during severe Bear Markets.  By reducing exposure when risk is high, our objective is to keep clients’ exposure to risk “in-line” with prevailing market conditions at all times. 

We also believe that it is important to perform well in a positive market environments.  We strive to “own the best and ignore the rest” by focusing portfolios on the market’s leadership (I.E. the top rated asset classes, stocks, sectors, countries, and industries).

This differs dramatically from the traditional asset allocation approach of diversifying assets evenly across asset classes.  We have one simple question of the traditional approach to asset allocation: Why would you want to own any index, country, or sector that isn’t performing?  Instead of “planned mediocrity”, we employ our proprietary, state-of-the-art Adaptive Leadership approach to asset allocation.

HCM’s Three Steps to Successful Investing

Step One:  Identify the “Big Picture”

Successful Investing starts with identifying the Market’s Environment in terms of risk versus reward.  This is critical to success over the long term because different environments require different strategies. In short, using the same aggressive strategy that is successful in a bull market can be devastating in a bear market.  We believe Portfolios must have the flexibility to adapt to the current environment. 

Step Two:  Focus on the Leaders – The Adaptive Leadership Strategy

We feel it is important to “make hay while the sun shines” by focusing our portfolios on the market’s leaders.  Our proprietary Adaptive Leadership Strategy is a disciplined method of Asset Allocation designed to keep portfolios focused on the Market Leadership at all times. We focus both on the question of Growth versus Value and Cap Size (Small Cap, Mid Cap and Large Cap). 

Step Three:  Manage Risk (Stay “In-Line” with Conditions)

The final step in successful portfolio management is to “know when to hold ‘em and know when to fold ‘em.”  While there are never ANY guarantees in investing and gains are never assured, our disciplined approach to managing risk is designed to keep portfolios “in-tune” with the overall condition of the market at all times.  We utilize a graduated approach when adjusting our exposure to market risk based on our proprietary Model of Models Risk Management System. 

What is Risk Management?

We define Risk Management as: the art of keeping portfolio exposure to market risk “in-line” with the prevailing market conditions at all times.

The goal is to keep portfolios mostly invested during positive market cycles and to reduce exposure to market risk during severe market declines.  While there are never any guarantees in investing, doesn’t it make sense to have a strategy designed to lose less during bear markets and severe declines?

Why is Risk Management Needed?
To answer simply…to reduce risk. It is safe to assume that no investor would have intentionally remained fully invested during the “Tech Bubble” Bear Market, which occurred between 3/31/00 through 3/31/03 where the average Growth Fund (as defined by the Lipper Large Cap Growth Fund Index) lost -64%...and needed to gain more than 180% to get back to breakeven.

History has proven there are definitely times to be fully invested, there are times to keep some money on the sidelines, and there are times where a reduced risk profile is warranted. So, why would you want to stay fully invested all the time if you don’t have to?

In General, Mutual Funds Don’t Manage Risk!
A good reason to manage risk is traditional mutual funds won’t do it for you. The simple truth is that the vast majority of mutual fund managers stay almost fully invested at all times. Why? First, because many times the prospectus requires it. Second, the sheer size of most funds precludes them from reducing exposure in any meaningful way during market declines.

The Least Loss Principle

It is important to understand that no investor is immune to declines in their account during severe Bear Markets.  However, unlike the blindly implement “buy & hope” approach, our goal is to attempt to limit the degree of pain that the grizzly beast inflicts on our portfolios.

Let’s take a moment to be very clear on this concept.  Should you expect us to sell our positions at the very top of Bull Market peaks and then become reinvest at the depths of Bear Market declines?  Of course not.  Will we avoid the entire decline during Bear Market drops?  Unequivocally no…we are money managers not magicians.

In summary, our objective is to lose the least amount possible during a Bear Market decline.  Practically speaking, our approach demands that we reduce exposure to market risk whenever a high-risk environment develops.

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Adaptive Leadership Strategy

HCM’s Adaptive Leadership Strategy is a disciplined method of Asset Allocation designed to keep portfolios focused on Market Leadership at all times.

Traditional Asset Allocation programs allocate assets across all asset classes in an attempt to smooth out returns in different market conditions and then take a static, set-it-and-forget-it approach.  However, it is our opinion that in reality, this is little more than an exercise in “planned mediocrity”.  Our question is why would you want to own any investment class that is underperforming?  We believe a portfolio should stay focused on the leading classes and ignore the laggards.  In short, our goal is to continually adapt our portfolios’ focus to the leaders – thus staying invested in the leading classes at all times.

The Adaptive Leadership Strategy identifies leadership in terms of asset classes according to Style (Growth vs. Value) and Size (Small-cap, Mid-cap & Large-cap). The key question is which of the six classes will outperform in the current environment? 

One of the most important aspects of our research is that we have identified factors that have lead to class outperformance.  This is not the typical, momentum based, rear-view mirror strategy (i.e. buying the class that was last month’s winner) that is fraught with risk.  Our research shows the indicators below have proved to be excellent guides to which class is likely to be the best performer in a given environment:

How Does it Work?

The Adaptive Leadership Strategy is designed to focus on the leading asset classes over intermediate-term and long-term time frames.  Each week we review our models to determine the leading class in terms of Style and Size.  Based on our target exposure for each portfolio, one-third of the exposure is allocated to the leading index in terms of Cap Size (Small-cap, Mid-cap or Large-cap).  One-third is allocated to the leading Style and Size Class (Small-cap Growth, Small-cap Value, Mid-cap Growth, Mid-cap Value, Large-cap Growth, and Large-cap Value) for the intermediate term and the final one-third is allocated to the long-term Style and Size leader.  As an example, the allocation for March 1, 2007 is:

33% Large-Cap

33% Large-Cap Value

33% Mid-Cap Growth

In sum, while there are never any guarantees in investing, HCM’s Adaptive Leadership Strategy for Asset Allocation is designed to keep portfolios focused on Market Leadership at all times, in all market conditions.

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HCM’s Model of Models Risk Management System

We strongly believe that Risk Management should be part of every investor’s portfolio.  With the 2000 - 2002 (actually it was 3/31/00 - 3/31/03) Bear Market causing losses to exceed -60% (actually, it was -64.76%) for the average Growth Fund (as defined by the Lipper Large Cap Growth Fund Index), we are confident that, if given a choice, most investors would prefer to try and avoid losses of that magnitude in the future.

We define Risk Management as keeping client’s exposure to market risk “in-line” with market conditions at all times.  In short, we strive to position portfolios with less exposure during high risk environments and more exposure during Bull market cycles.  The ultimate objective is for clients to benefit from Bull markets and to reduce exposure to market risk during Bear market declines.

The Model of Models System is a disciplined approach to Risk Management and is designed to keep our portfolios “in-tune” with the overall State of the Market.  It uses a graduated approach to changes in exposure and focuses on an Intermediate Term Time Frame (6-13 weeks). 

The HCM Model of Models Risk Management System’s components:

Market Environment  (30% of the Model)

Trend of the Market  (40% of the Model)

Market Momentum   (30% of the Model)

Within each component are as many as nine independent indicators or models - each being successful in its own right.  For example, the Momentum Component consists of three Momentum Systems (each controls 10% of the model’s overall exposure). The Trend Component has four separate trend systems (controlling a total of 40% of the exposure) and the Environment Model gets 30% of the weight. 

How Does it Work?

The functionality of the approach is straightforward.  If the model portfolio is 100% invested and one of the Momentum indicators gives a sell signal – we would reduce exposure by 10%. If another gives a sell we would cut another 10%.  If the Environment Models were to also then go negative, the exposure to market risk would be down to 50%.  Thus, the model can go to 100% cash during severe Bear Markets – but is unlikely to do it all at once as the primary goal is to stay “in-line” with conditions.

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