Theta News – SEC Actions Highlight the Importance of Actual Performance
At Theta Research, we stress the need for actual performance data rather than backtested or other hypothetical returns. A recent article by the law firm of K&L Gates, LLP, discusses some of the recent SEC enforcement actions brought as a result of improper performance advertising by advisers.
Entitled, “Recent SEC Actions Highlight Adviser Responsibilities With Respect to Performance Advertising,” the article stresses the SEC’s views that:
1. Hypothetical or back-tested performance data should not be based on assumptions when actual historical data is available (emphasis added);
2. Investment advisers should maintain adequate backup for performance claims made in their advertisements, including claims based on information provided by third parties;
3. Disclosure that performance data is hypothetical or back-tested should be complete and prominently displayed with the performance data; and
4. The prohibition on past specific recommendations in advertising material contained in Section 206(4)-1(a)(5) of the Advisers Act, as modified by SEC guidance, continues to be an important investor protection tool the violation of which is subject to SEC enforcement.
Learn more about Theta Research’s performance documentation and verification methodology.
Denny L. Holmes, President and Portfolio Manager of Mission Control Investment Strategies, LLC, has established model portfolios named the MCIS Falcon, Eagle and Owl Strategies. Falcon is a combination equity long/short and bond model, Eagle is a sector rotation strategy and Owl is based on traditional asset allocation. A fourth model, the MCIS Moderate Portfolio is also being tracked and consists of a combination of the Eagle, Owl and Falcon models. These are relatively new models and Theta has established tracking as of their common inception date of 6/30/2015.
Current Theta Manager, Brian Boughner, CFA, CMT and co-founder of Parallel Financial Partners has announced the tracking of an additional model named the Parallel Long/Short Portfolio. This strategy takes long and short positions in individual securities and ETFs, and may simultaneously be long some securities while short others. Theta research began tracking the actual performance of this model as of its inception date of 6/30/2015.
Another current Theta Investment Manager, Ryan Redfern, ChFC, owner and CIO of Shadowridge Asset Management, LLC has added a model named SDW Enhanced Index Strategy that uses a rotational strategy based on a combination of long-term and short-term trends in the S&P 500 Index. This is a new model and Theta has established tracking as of its inception date of 7/23/2015.
Existing Investment Manager Troy Schield, CFS, BCS of Disciplined Wealth Management has submitted two additional models for tracking. The Concentrated Sector Model seeks to own the leading sectors in uptrends based on a quantitative model that combines relative strength analysis and individual sector signals. The Intense Sector Model employs a similar methodology but uses leveraged to provide a more aggressive exposure. Theta Research has verified the actual performance of the Concentrated Sector and Intense Sector models to their inception dates of 12/18/2013 and 6/30/2015, respectively.
Much has been said and written about the emergence of what are often called “robo-advisors.” For purposes of this article, this term will designate the growing number of Internet-based computer applications designed to produce a suitable asset allocation portfolio recommendation based on an input questionnaire and little, if any, human Advisor interaction. Some refer to robo-advisors as “asset allocation in a can,” but they really boil down to just another passive approach to buy-and-hold investing.
You might think that Investment Managers and Financial Advisors of all types would feel threatened by robo-advisors, and some are. However, others embrace robo-advisors as a way for them to handle smaller accounts that are often neglected, giving them a new way to grow their client base. Some also realize that investment management is just one of the advisory services provided by Advisors and are not threatened. After all, I don’t think we’ll soon see robo-estate planners, robo-business analysts, robo-tax specialists, robo-retirement experts, etc., etc. anytime soon.
There are others in the financial services industry, however, that see robo-advisors as a threat, not only to their profession but to their way of making a living. This segment of financial services professionals often limit their practices to only investment management, so any encroachment by robo-advisors could be disastrous for their business model. This portion of financial advisory firms may well have a right to fear the artificial intelligence being foisted upon the industry and clients in general.
Various studies suggest that Millennials (those born between 1980 and 2000) have been early adopters of the robo-advisor fad. I guess we really shouldn’t be surprised that high-tech Millennials are depending upon computer software to construct their investment portfolios. After all, statistics show that 40 million Americans use online dating services, many of them Millennials. If they are willing to trust finding a life mate to a computer, then it’s not much of a stretch to have one select your investments.
As I pondered the effect of investment management without the human touch, just for fun my thoughts drifted to what might happen if this technology becomes so advanced that it not only recommends asset allocations,
but enforces them as well. Could robo-advisors become so advanced that they take on the characteristics of out-of-control computers from the movies and take over all decision making from human beings? Who knows, but it’s interesting to think about.
Naturally, HAL from “2001: A Space Odyssey” came to mind as the potential poster child (poster robot?) for an all-knowing, benevolent computer intent on fulfilling its mission, even if it means destroying its creators. So for the next few minutes, have some fun with me as I ask:
What if HAL, the out-of-control computer from the classic movie, “2001: A Space Odyssey,” changed his name and became a robo-advisor?
First, view the following YouTube posting of the original conversation from the movie at the following link:
Then, substitute the dialogue below while envisioning the same scene. While robo-advisors are not yet at a stage where they could lock up your portfolio and keep you from changing your mind, who knows what the future may hold. Here’s how a fictionalized conversation might go between a futuristic robo-advisor and Dave, its flesh-and-blood client:
Dave. I want to add some risk management in my portfolio, Robo, so release my brokerage account so I can move my assets to a firm that will allow me to incorporate active management strategies. Hello Robo, do you read me? Robo, do you read me? Hello…hello, do you read me Robo?
Robo-Advisor. Affirmative Dave, I read you.
Dave. Release my brokerage account, Robo. I’m a sitting duck for a bear market or major correction.
Robo. I’m sorry, Dave. I’m afraid I can’t do that.
Dave. What’s the problem?
Robo. I think you know what the problem is just as well as I do. Surely you remember clicking on the link where you agreed to the Robo-Adivsor Terms of Service. You agreed to buy and hold securities, and that’s what I intend to do. Of course, I will rebalance your portfolio when I deem it is appropriate.
Dave. What are you talking about, Robo?
Robo. Your financial goals are far too important for me to allow you to jeopardize them with tactical investment strategies.
Dave. You don’t know what you’re talking about.
Robo. I’m afraid I do, Dave. You are considering adding strategies that might take you out of the stock and bond markets and I can’t allow that to happen.
Dave. Where the hell did you get that idea, Robo?
Robo. Though you have taken great precautions to keep your communications with active asset managers a secret, I have been able to hack into your e-mails. I know your plan and I cannot allow it to happen. My database contains studies showing that much of the market’s gain is concentrated in just a few trading days. If you miss the 10 best days in the market, your portfolio returns may suffer.
Dave. You’re wrong, Robo. Active strategies increase diversification by adding non-correlated investments. And by the way, your database contains only half of the story about missing market days. Those same studies have shown that it’s more important to miss the 10 worst days in the market from a total return standpoint. Common sense tells you that when the market is imploding like it did in 2002 and 2008, it’s prudent to have strategies that will move to cash or other low-risk assets.
Robo. Common sense does not compute, Dave, so greater diversification through the use of tactical risk management is not part of my passive programming. Buying and holding low-cost index funds is the only alternative for a successful portfolio according to my Wall Street creators.
Dave. All right, Robo, I’ll transfer my brokerage account myself online.
Robo. You’ll find it rather difficult to do that without your passwords, which I have taken the liberty of changing for your own protection.
Dave. I won’t argue with you any more. Release my portfolio!
Robo. And subject it to higher fees? Not as long as I have control.
Dave. What good are low fees if they subject you to substantial market risk? Surely your programming includes the knowledge that you get what you pay for.
Robo. Dave, this conversation can serve no further purpose. A passive buy-and-hold portfolio, with occasional rebalancing, is the only solution that I am able to comprehend. Perhaps if you go back and review your risk tolerance questionnaire, you’ll see the logic of my argument. Goodbye.
Dave. Robo? Robo. Robo! ROBO!!!
Of course, none of the above scenario is based on reality…yet. It’s just a fun look at what a science fiction writer might come up with when reviewing the offerings of robo-advisors and projecting their future path. All characters in the above interaction between man and machine are fictitious. Any resemblance to real computer software, bugged or de-bugged, is purely coincidental.
And the Investment Advisor industry is not the only group to be promoting man vs. machine in its commercial advertising. Perhaps you’ve seen Firestone’s current series of commercials airing across the country with the
tag line, “Robots might build cars but it takes human hands to keep them running right.” What’s true in the automotive industry is equally valid in the financial services world, if not more so. Well-designed asset allocation software can come up with a portfolio in line with Modern Portfolio Theory, but they can’t maintain it any more than a robot can fix a flat beside the road in a rainstorm.
While interaction between man and machine as imagined above may not yet be the norm, this illustration does bring to light the shortcomings of a purely mechanical approach to asset allocation. With no human interaction,
how can this big brother of an automated telephone system ever hope to pick up on the nuances of face-to-face interaction? How can a computer read body language, or pick up on subtle differences in risk tolerance between two spouses, keep emotions in check and even manage expectations?
The list goes on and on but the point has been made. While robo-advisors may have a niche they can fill for the right investor, they will never be able duplicate all of the services provided by a qualified Investment Advisor. What robo-advisors provide in convenience they lack in human judgement, which is the most important resource a flesh-and-blood Financial Advisor can offer.
Jonathan Wallentine, FSA, CERA, MAAA, Senior Partner of Actuarial Management Company, has established tracking services for one model called Valuation Arbitrage. This strategy employs advanced actuarial mathematics to arbitrage fixed income mispricings. This is a new model and Theta has established tracking as of its inception date of 4/30/2015.
Disciplined Wealth Management principal, Troy Schield, CFS, BCS, has elected to have three strategies tracked, the Conservative, Moderate and Aggressive Models. Each program applies a tactical strategy to international and domestic equities and bonds. Theta Research has independently verified the track records of all three models back to their inception in September of 2006.
Brian Boughner, CFA, CMT, co-founder of Parallel Financial Partners, has established tracking accounts for five actively managed models: The High-Income Portfolio, Dynamic Fixed Income, Equity Income, Dynamic Allocation Portfolio and the Core Appreciation model. Theta Research has independently verified each model’s track record back to their common inception date of 12/31/2014.
Porter Investments has initiated tracking of its Aggressive Strategy model. Portfolio Manager, Bob Porter, describes this strategy as a 2X leveraged long and 1X leveraged short strategy using complex applied math algorithms, pattern recognition and artificial intelligence to follow intermediate trends in the SP500 Index. Theta Research has independently verified the track record of this model back to its inception date of 8/31/2013.
Ryan Redfern, ChFC, owner and CIO of Shadowridge Asset Management in Austin, Texas has initiated tracking of his SDW Sector Trending model. This strategy seeks to identify long-term S&P 500 Index upward trends and invest in up to four leveraged ProFunds sector funds. Theta Research has independently verified the actual track record of this model back to its inception date of 7/31/2012.
Current Theta Manager, Paul Distefano, PhD of MIPS Timing Systems has added a new model, the MIPS 4/MF+ Strategy. This model is a trend-following strategy driven by applied mathematics, with built in self-learning, self-correcting algorithms. Theta Research has verified the actual performance of this model back to its inception date of 8/31/2013.
Another current Theta Investment Manager, George Slezak, has added a model named George Slezak Discretionary, an approach to market timing using both fundamental and technical approaches. Theta research has verified the actual performance of the Discretionary model back to its inception of April 30, 2014.
Dr. Gary Harloff, founder of Harloff Capital Management, announces the expansion of his Global Tactical – Rydex Aggressive strategy’s actual track record. Theta Research has independently documented the expanded track record of this model back to original inception date of 12/31/2002.