How I Invest

If you’re reading this, you are about to get into a level of detail that I believe is at the heart of what makes my investment process distinctively different from other investment advisors. Thank you for taking the time.

After establishing the client’s financial objectives, resources, and risk tolerance, I establish an investable combination of equity and bond ETFs to form the basis of the benchmark that will be used to measure my performance over time (described below). Having back-tested sample benchmarks against asset allocations produced by several of the popular robo-brokers, I have found that my benchmark approach provides similar or better-annualized returns (depending on the time frame) with lower risk and higher risk-adjusted returns – thus producing a challenging target for my investment performance. This is one of several distinct differences in my approach compared to most other investment advisors.

Once the benchmark has been set, I develop an initial asset allocation based on current macroeconomic and market conditions and implement the process by which the account will be managed over time. With further explanation to follow, my investment process can be characterized as a hybrid of technical and fundamental analysis by:

Following trend and momentum using moving averages over different time frames and
Using sustaining relative performance of securities relative to the benchmark funds,
All taken in the context of developing macroeconomic conditions and corporate revenues and profits.

My investment philosophy is best characterized as a hybrid approach using macroeconomic developments to inform current investment strategy while using both fundamental and technical analysis to inform asset allocation and trading decisions. I do not believe in a buy-and-hold approach nor do I believe in rebalancing based on a set schedule or when the underlying asset allocation shifts from established targets. The general methodology is explained below.

Lane invests through Interactive Brokers, which provides its own custodian services. Interactive Brokers provides a unique capability that enables Lane to create and trade one or more portfolios of 100 stocks or more, ETFs, CEFs, and mutual funds as single securities, simplifying the process of managing clients with similar objectives in a consistent manner.

I believe in both strategic and tactical asset allocation:

Strategic refers to allocations I expect to be in place over the long haul.
Tactical refers to how I modify the strategic allocation to take advantage of opportunities as they arise.

To determine appropriate allocation percentages for a strategic allocation, I identify client financial goals, resources, and risk tolerance (volatility) and modify the starting point accordingly. Then, when I implement a tactical allocation, these factors and others discussed above are used to adjust the strategic percentages.

I invest in individual stocks, exchange-traded funds (ETFs), and closed-end funds (CEFs). It should be noted that all investments carry a certain measure of risk (volatility) with equities typically experiencing more risk than fixed-income investments and individual stocks experiencing more risk than diversified funds.

For each client, I establish a benchmark to measure my performance on an ongoing basis. This benchmark may be based on some combination of investable index funds (SPY for the S&P 500 total return domestic equity index; VEU for the FTSE All-World ex-US index; and LQD for the iBoxx $ Investment Grade Corporate Bond index), the Consumer Price Index, or some combination of both approaches. I maintain five investment strategies with the following benchmark(s):

Very aggressive: 100% SPY
Balanced aggressive #1: one-third allocation in each of SPY, VEU, LQD
Balanced aggressive #2: 70% SPY, 30% LQD
Balanced conservative: 50% SPY, 50% LQD
Most conservative: 100% LQD

Each client portfolio will have a single performance benchmark. Actual investments, selected on a tactical basis, will be comprised of some combination of the benchmark and individual securities (stocks, exchange-traded funds and/or closed-end funds). Unless specifically requested by a client in writing, any one security will not exceed 15% of the total portfolio (10% in the case of individual stocks) at the time of purchase though positions may exceed 15% due to appreciation.

While market conditions are essentially continuously monitored, client portfolios are evaluated not less often than weekly and may be rebalanced or modified at any time. Within the Folio Institutional environment, rebalancing may appear as very active trading while the actual impact may only be relatively small changes to the securities held in the portfolio.

To keep informed of macroeconomic events, I read a wide range of online resources regularly, including publications and interviews of major investment managers, investment analysts, and economists, in addition to business and economic publications. By gaining a broad range of opinions, I can formulate and act on my economic outlook without the constraints that might be imposed if I were a representative of a larger organization.

I use both fundamental and technical analysis for security selection and asset allocation. For fundamental analysis, I may identify individual stocks based on their financial strength (with a focus on the firm’s leverage), profitability (with a focus on revenue and profitability regarding the firm’s history and its industry), and valuation measures (with a focus on PE and other select ratios in relation to the firm’s history and its industry). I also examine analyst reports, including buy/hold/sell recommendations, price targets, and key events.

I use technical analysis to make decisions about asset selection, allocation, and trading. In general, the technical approach I use is based on trend and momentum analysis using a variety of moving averages of security (or index) prices. The rationale for using trend analysis is two-fold:

First, I believe security prices are not random, but follow a trend based on underlying factors such as corporate earnings, inflation, interest rates, and geopolitical currents that tend to persist for some time.
Second, a great many investment managers follow these trends, causing inflection points and trend continuation to be somewhat self-fulfilling.

In addition to the above, my stock selection process is based on the view that there is constant rotation within various stock “universes” or indices such as the S&P 500, the NASDAQ 100, the Russell 2000, and others. Using a proprietary scan, I identify candidate stocks for purchase that reflect recent outperformance relative to the S&P 500 total return index ETF, SPY. From this group of candidate stocks, I invest in those whose technical characteristics (trend and momentum) are such that I believe will continue to be reflected in their future performance. I dispose of stocks that no longer show those characteristics.

The investment goal is to achieve portfolio appreciation above the benchmark over time. Turnover in the account could range from extremely low to excessively high depending on market conditions and investing opportunities. However, the fundamentals of trend analysis and momentum investing include finding entry points for emergent trends and sticking with successful trades. In such conditions, turnover in the account would remain quite low. Both short-term and long-term capital gains will be generated in the portfolio style. The portfolio style follows a multi-asset framework which allows me to invest in multiple asset classes depending on risk/reward opportunities and potential returns.

I control risk in the following ways:

First and foremost, I rely on continual monitoring of emerging economic and political events that can cause the market to suddenly change direction as well as events that impact current holdings. When an event justifying a change occurs, my approach is to remove affected investments from all portfolios at a common price so that each investor is treated equitably.
Following periods of significant advance, I may shorten the moving average period to increase sensitivity to trend reversal.
I limit the majority of my investments to securities that are actively traded in significant volume to avoid potential market manipulation or wide bid/ask spreads.
For equity allocations, I maintain portfolios of approximately 100 or more equally weighted stocks that are also diversified by industry and market capitalization. Therefore, no individual stock or stock sector will have an inordinate impact on the portfolios I create.
Finally, I maintain active contact with the market while traveling or on vacation, regardless of where I am, so that I can react quickly to the information that may have a trend-changing impact on the market or a specific security in the portfolio.

While my process of monitoring overall market direction can result in removing market risk prematurely, my primary goal is to protect portfolios from severe deterioration even if the result falls short of my benchmark goal.

I believe in using technical analysis because the method strips away the often conflicting points of view of even the most highly regarded investment analysts and firms. In addition, I find:

Security prices and the relative performance of security prices tend to remain in a discernible trend over some time depending on factors unique to the specific securities and the economic environment, and
Trends and, especially, reversals in trend, tend to be self-reinforcing on account of the number of trend-following analysts using similar techniques.

While the approach is imperfect, as all investment strategies are, and past performance is no guarantee of future results, I believe the results over time justify the effort involved. Here are some illustrations of how the approach has worked in the past.

In the next chart, we see the weekly price of the Vanguard S&P 500 Index fund for the period from 1995 through 2016, adjusted for dividends to illustrate total return. By following the 60-week moving average (for trend) and being sensitive to extreme readings in the MACD (for momentum shifts and confirmation of trend), owning the fund while the price was above the moving average and the slope of the moving average was positive and being out of the fund when the price was below the moving average and the slope was negative would have produced a higher total return than a buy-and-hold position.

The closer a transaction is made to the top or bottom of the trend, the more valuable the methodology is relative to buy-and-hold. Moreover, following the simple trend rule would have not only avoided the market corrections in 2001 and 2008, but it would also have provided valuable signals for market reentry. The false signals, as it turned out, that occurred in 2010, 2011, and 2015 would have been a small price to pay for the overall performance of the method.

The next chart shows the relative performance (the ratio) of the total return of the Vanguard S&P 500 index fund to the total return for the Vanguard Total Bond Market index fund. Generally, as in the chart above, when the ratio is above the red trend line (also a 60-week moving average in this case) and the trend has a positive slope, it was advantageous to have a portfolio weighting favoring equities and when the ratio was below the trend line and the trend line retained a negative slope, it was advantageous to have a portfolio weighting favoring bonds.

Once again, there were times when a “whiplash” occurred when the ratio moved rapidly above and below the trend and the slope changed quickly. Trading at these times would have resulted in a small price to pay for the overall total return of the method.

Each of these charts illustrate that the method is not designed to try to capture the top or the bottom of the market, something that is impossible to do with any consistency anyway. Therefore, there will be times, maybe months in length, that we will be on the “wrong side” of the market (using daily rather than weekly trends can shorten the length of these periods but may have other drawbacks). This underscores the need to stick to the methodology even when it seems to going against current markets. This is good practice regardless of the investment strategy being implemented but can make some month-to-month returns unattractive.

Having said all this about my methodology, I find the greatest concern among investors is the potential for being caught in a major market meltdown. Even though I believe in a positive long term outlook for the securities markets, when corrections do occur, it can take a number of years before value is restored.

Although the above charts provided good signals for avoiding recent corrections and may do so again, I employ additional techniques to help assure that my clients are not “caught” when the next one comes along:

The first is an independent “trigger” (independent of the actual investments within a client’s current portfolio and independent of market pundits and my own market views) based on 25- and 50-week exponential moving averages (EMAs, which are more sensitive to recent data than are simple moving averages) applied to an exchange-traded fund representing the total return on the S&P 500 (SPY). When price breaks below both EMAs, as it did 7 times since 1992, I take that as an indication to begin removing risk exposure from the portfolio, the speed of which depends on economic and market valuations at the time. If the slope of the 50EMA turns negative, that would increase the speed with which I would take risk off the table. If the 25EMA crosses over the 50EMA from above (as it did at the red arrows below), that would be a signal to me to significantly reduce risk exposure. As with any trading methodology, there can be misleading signals (the most recent correction in 2016 may be one example though it's a little too early to tell for sure). That said, since we don’t know at the time of a signal how deep a correction might be, I’d rather pay the price of too much caution than too little.

Technical analysis and application of the rules are not perfect; no investment methodology is. And past performance should not be taken as a guarantee of what will happen in the future. With that understanding, technical analysis provides a sound basis for investing that strips away much of the often-conflicting opinion-based ambiguity of a more fundamentally oriented approach.

As described above, my primary choices for equity investments are individual stocks, exchange-traded funds (ETFs), and closed-end funds (CEFs). My primary reasons for using ETFs are their low cost, tax efficiency, ease of trading, index-orientation, and diversity of offering. A useful description of ETFs and CEFs can be found at http://www.etfguide.com/etfeducation.htm.

An investment in a single exchange-traded fund involves the risk of losing money and should be considered part of an overall program, not a complete program. An investment in ETFs, like other investments, can involve risks such as: lack of diversification, price volatility, competitive industry pressure, international political and economic developments, possible trading halts, and index tracking error.

The following is a summary of the risks of investing. Please note that this list is not exhaustive, and has been provided as an indication of the factors that can affect the value of your investments.

Equity Risk: Investors in equity securities may be exposed to a high level of risk because the prices of equity securities can rise and fall significantly in a short period of time. This could arise due to the fortunes of the companies that issue them or with general stock market or economic conditions.

Interest Rate Risk: A change in general interest rates is one of the biggest factors affecting fixed-income securities, including ETFs and mutual funds that invest in fixed-income securities. A bond for example, pays interest based on the level of interest rates prevailing when the bond is issued. Generally, if interest rates fall, the values of the bond rise. Conversely, if interest rates go up, the value of a bond will decrease.

Inflation Risk: Inflation Risk is the risk of a decline in the purchasing power of the client’s savings due to a general rise in prices.

Foreign Currency Risk: Investing in securities that are priced in foreign currencies involves foreign currency risk. Securities that are priced in foreign currencies can lose value when the U.S. dollar rises against the foreign currency. As well, foreign governments and domestic may impose currency exchange restrictions, which could limit the ability to buy and sell certain foreign investments and could reduce the value of the foreign securities that are held by investors.

Foreign Market Risk: Foreign investments involve additional risks because financial markets outside of the U.S. may be less liquid and companies may be less regulated and have lower standards of accounting and financial reporting. In some countries, an established stock market and legal system that adequately protects the rights of investors may be lacking. Foreign investments can also be affected by social, political, or economic instability. Foreign governments may impose investment restrictions.

Liquidity Risk: Liquidity refers to the speed and ease with which an asset can be sold and converted into cash. Most securities can be sold easily and at a fair price. In highly volatile markets, certain securities may become less liquid, which means they cannot be sold as quickly or easily. Some securities may be illiquid because of legal restrictions, the nature of the investment, or certain other features such as guarantees or a lack of buyers interested in the particular security or market. Difficulty in selling securities may result in a loss or reduced return.

Exchange-Traded Fund Risk: Exchange-traded funds (“ETFs”) are securities that closely resemble index-oriented mutual funds, but can be bought and sold like common stocks:
- an ETF may not be “actively” managed. Such ETFs would not necessarily sell a security because the security’s issuer was in financial trouble unless the security is removed from the applicable index being replicated. As a result, the performance of an ETF may be lower than the performance of an actively managed fund;
- some ETFs employ leverage, which can magnify the risk of the underlying market segment or index;
- the market price of ETF units may trade at a discount or premium to its net asset value;
- an active trading market for an ETF’s units may not develop or be maintained; and
- there is no assurance that the requirements of the exchange necessary to maintain the listing of an ETF will continue to be met or remain unchanged.
- an ETF may fail to accurately track the market segment or index that underlies its investment objective;
- see http://etfdb.com/etf-education/hidden-risks-costs-etfs/ for a more comprehensive description of the risks of ETF investing.

Reallocation: Due to reallocation, positions may be sold or closed in the very short-term (e.g., within 30 days). Also, the same security may be bought for some accounts, while being sold for others. This may result in increased commissions for some clients. This reallocation does not take into consideration any tax implications that may result from this type of trading.

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