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March 9th, 2020

Chadd Mason, CEO The Cabana Group

All True Investing Takes Process and Perspective

Given the continued bloodbath we are seeing in stocks, this commentary serves as follow up to the Special Report we released just over a week ago, on February 29. In that report, we noted that all of our portfolios held within their respective target drawdown during the first week of the sell off, and that we had reallocated to positions that we believed would reduce risk should selling continue, all in the effort to protect our clients’ assets. We also noted that an explosive rally was likely early the week of March 2, due to short covering and extreme oversold conditions. Finally, we suggested that the real test would come after the rally faded and investors were left with the opportunity to resume selling. Unfortunately, the selling resumed, and by Friday, the February 28 lows were being tested. Throughout the weekend news of additional coronavirus cases worldwide consumed media. To make matters worse, on Sunday we learned that Russia and Saudi Arabia had begun an all-out energy price war. These two factors caused the S&P 500 futures market to lock limit down (trading halted at down 5%). Oil futures were down more than 20%, after an already huge drop over the preceding two weeks. It was clear last night that today would be a very ugly day for world equity markets.

As bond yields dropped to historic lows at the market open, U.S. indexes promptly fell 7% and trading was halted. This extremely rare safety mechanism was last implemented in 2011. Despite giving investors time for cooler heads to prevail, the broad indexes made no meaningful headway and ended at the lows of the day – down 8%. The continued selling in equities that we are now seeing is truly unprecedented. The fall from a market top through a correction of more than 10% and into a bear market has never happened this quickly. The S&P 500 is down 20% in thirteen trading days. While the crashes of 1929, 1987 and 2008 had drops of equal size, equity markets were already in sustained corrections. The current unabated dive from all-time highs in stocks is unequaled. The VIX (volatility index) hit levels last seen in 2008. We are seeing real panic in the stock market for the first time in a long time. It is in times like this that it is incredibly important to have an investment process in place that you understand and allows you time for perspective. At Cabana, we strive to provide just that – a process that is understandable, in addition to some perspective. In fact, all true investing takes both a process and perspective. So today, after the worst single day and worst three weeks in the stock market in a very long time, I thought I would provide a  little of both.

Our Process:  

We identify in numerical percentage terms the intended drawdown parameters of each of our portfolios. This is not a guarantee but is a clear objective that forms the basis of the investment. Our algorithm is designed to identify changes within the macro-economy and aggregate asset classes that perform relatively well at any given point in the repeating cycle, so long as the aggregated portfolio does not violate the predetermined drawdown of the portfolio. When conditions are good, the aggregated portfolio will have more risk type assets. When things    deteriorate, risk assets are incrementally removed and replaced with lower risk assets. When things improve again, risk assets are added back in. All Target Drawdown Portfolios work the same way. The amount of risk at any given time is a function of the target drawdown number (or percentage). By building portfolios with a predefined risk target at the outset, and then reallocating in response to things that matter to asset price, we attempt to remove only the amount of risk that is necessary to hold our losses around the target drawdown number. If we remove too much risk too soon, the portfolio will not be optimized for the best return when the market improves. When things get relatively bad (as they certainly are now), we want to be at or around our target drawdown when additional risk is removed. A lot like Goldilocks, we want our porridge just right. Historically, this process has been successful in removing risk as we reach our target drawdown in bad markets. This has been true over many conditions and during many crises.

We monitor drawdown from peak to trough based upon end-of-month data. In other words, the end-of-month high in the portfolio’s value marks the peak. The portfolio’s end-of-month low (no matter how many months later) represents the trough. We use end-of-month data because it is consistent with our overall GIPs performance verification. We employ independent verifiers to review end-of-month composite performance data and report returns, statistics, and drawdown. We do not report or calculate intra-month highs and lows. It is a bad idea to get too excited one way or the other over short-term swings that occur within each day, week and month. Some argue that only quarterly data should be reported but I am not that patient. For purposes of today’s perspective, I will provide gross-of-fees returns, which have not been independently verified, from intra-month highs in each portfolio, as well as longer-term performance numbers.

Some Perspective:

S&P 500

  • 2019 Return: +31.20%
  • 2020 YTD Return: -15.0%
  • Drawdown since end-of-month high (Dec. 31, 2019): -15.0%
  • Drawdown since intra-month high (Feb. 19, 2020)- 19.3%
Target Drawdown Income 5  
  • 2019 Return: +10.93%
  • 2020 YTD Return: -3.7%
  • Drawdown since end-of-month high (Jan. 31, 2020): -4.4%
  • Drawdown since intra-month high (Feb. 19, 2020): -5.6%
Target Drawdown 7  
  • 2019 Return: +21.18%
  • 2020 YTD Return: -4.5%
  • Drawdown since end-of-month high (Jan. 31, 2020): -4.7%
  • Drawdown since intra-month high (Feb. 19, 2020): -7.7%
Target Drawdown 10
  • 2019 Return: +24.94%%
  • 2020 YTD Return: -5.1%
  • Drawdown since end-of-month high (Jan. 31, 2020): -5.9%
  • Drawdown since intra-month high (Feb. 19, 2020): -10.4%
Target Drawdown 13  
  • 2019 Return: +25.44%
  • 2020 YTD Return: -7.9%
  • Drawdown since end-of-month high (Jan. 31, 2020): -8.8%%
  • Drawdown since intra-month high (Feb. 19, 2020): -13.8%
Target Drawdown 16  
  • 2019 Return: +31.59%%
  • 2020 YTD Return: -9.7%
  • Drawdown since end-of month-high (Jan. 31, 2020): -10.6%
  • Drawdown since intra-month high (Feb. 19, 2020): -15.1%
Target Drawdown Efficient 10  
  • 2019 Return: +15.02%
  • 2020 YTD Return: -7.0%
  • Drawdown since end of month high (Jan. 31, 2020): -7.1%
  • Drawdown since intra-month high (Feb. 19, 2020): -7.6%
We have been able to keep risk on in times of favorable market conditions and remove risk as things deteriorate. The hedge built into the portfolios, as well as the amount of risk removed during reallocation, is what results in the statistical linear relationship (upside and downside) within our family of portfolios. The Target Drawdown number dictates the performance of the portfolio during good times and bad. It is that simple. Our goal is to enable investors to select a portfolio that matches their risk tolerance and objectives. The higher risk tolerance investors are able to select a larger drawdown parameter, while those with lower tolerance are able to select a smaller drawdown parameter.

Since we reallocated on February 28, we have been able participate in market rallies, yet avoid most of the downside. For example, our flagship Target Drawdown 10 Portfolio has averaged 2/3 of the upside during last week’s rallies, while realizing less than 1/3 of the downside. Today, when the S&P 500 was down 8%, the Target Drawdown 10 was down 3.7%. Although there is nothing fun about being down 3.7% in a day, the portfolio is doing what it was designed to do. This is exactly the type of performance structure you want to see while staying invested during periods of high market volatility… and we remain within our monthly drawdown targets.

Our most recent fact sheets reflecting performance of all our portfolios through February can be found here.

I hope this report helps to calm some nerves that are out there, instill some confidence in the process and provide some much-needed perspective. As always, a big thank you to all our advisor partners and investor clients who continue to trust us with their hard-earned reputations and assets. Our algorithm has signaled an imminent scene change and we are currently in blackout preparing to reallocate. Once that reallocation takes place we will be in our Bearish Scene. We will continue to monitor and report our perspective as the situation progresses.

IMPORTANT DISCLAIMERS
This material is prepared by Cabana LLC, dba Cabana Asset Management and/or its affiliates (together “Cabana”) for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed reflect the judgement of the author, are as of the date of its publication and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Cabana to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Cabana, its officers, employees or agents.

This material may contain ‘forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. All investment strategies have the potential for profit or loss. All strategies have different degrees of risk. There is no guarantee that any specific investment or strategy will be suitable or profitable for a particular client. The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal.

Cabana LLC, dba Cabana Asset Management (“Cabana”), is an SEC registered investment adviser with offices in Fayetteville, AR and Plano, TX. The firm only transacts business in states where it is properly registered or is exempted from registration requirements. Registration as an investment adviser is not an endorsement of the firm by securities regulators and does not mean the adviser has achieved a specific level of skill or ability. Additional information regarding Cabana, including its fees, can be found in Cabana’s Form ADV, Part 2. A copy of which is available upon request or online at www.adviserinfo.sec.gov/.

The Financial Advisor Magazine 2018 Top 50 Fastest-Growing Firms ranking is not indicative of Cabana’s future performance and may not be   representative of actual client experiences. Cabana did not pay a fee to participate in the ranking and survey and is not affiliated with Financial Advisor magazine. RIAs were ranked based on percentage growth in year-end 2017 AUM over year-end 2016 AUM with a minimum AUM of $250 million, assets per client, and growth in percentage assets per client. Visit www.fa-mag.com for more information regarding the ranking.

The Financial Advisor Magazine 2019 Top 50 Fastest-Growing Firms ranking is not indicative of Cabana’s future performance and may not be representative of actual client experiences. Cabana did not pay a fee to participate in the ranking and survey and is not affiliated with Financial Advisor Magazine. Working with a highly-rated advisor also does not ensure that a client or prospective client will experience a higher level of performance. These ratings should not be viewed as an endorsement of the advisor by any client and do not represent any specific client’s evaluation. RIAs were based on number of clients in 2018, percentage growth in total percentage assets under management from year end 2017 to 2018, and growth in percentage growth in assets per client during the same time period.  Visit www.fa-mag.com for more information regarding the ranking.

No client should assume that the future performance of any specific investment or strategy will be profitable or equal to past performance. All investment strategies have the potential for profit or loss. All strategies have different degrees of risk. There is no guarantee that any specific investment or strategy will be suitable or profitable for any investor. Asset allocation and diversification will not necessarily improve an investor’s returns and cannot eliminate the risk of investment losses. While loss tolerance and targeted “drawdown” are identified on the front end for each portfolio, Cabana’s algorithm does not take any one client’s situation into account. It is the responsibility of the advisor to determine what is suitable for the client. An advisor should not simply rely on the name of any portfolio to determine what is suitable. Cabana manages assets on multiple custodial platforms. Performance results for specific investors may vary based upon differences in associated costs and asset availability.

Cabana claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a trademark of the CFA Institute. The CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To receive a GIPS Report and/or a firm’s list of composite/pooled fund descriptions please email your request to info@thecabanagroup.com.