"RISK-LIMITING TECHNIQUES"

In the stock and bond markets, uptrends alternate with downtrends on an unpredictable basis.  For Sierra clients, it is important that we limit their exposure to downside risk during nasty market episodes – especially protracted "bear markets".

To this end, we monitor on a daily basis, and we implement our risk-limiting disciplines.  We do not try to predict market tops or bottoms, but – as illustrated in the chart below – we react to significant, actual trend reversals:  When a given Designated Fund turns down by an amount which is more than a normal fluctuation, we move the relevant assets temporarily out of the fund and into the safety of money market or other short-term haven.  Then, when the Designated Fund turns back up by a significant amount, we move the assets back into that fund – unless in the interim, we have decided on a more attractive fund.

Please note that our goal is not to “beat buy-and-hold”, or to “beat the market”.  The primary goal of our Defensive Timing discipline is to protect your account from any continuation of the downtrend in that Designated Fund.

Our Defensive Timing^SM discipline is not predictive, or based on our views of what lies ahead.  We simply react, with our well-tested discipline, to actual and significant reversals in the Total Return trend (price changes plus accrual of yield, if applicable) of each fund.

The amount of fluctuation we tolerate before switching varies with the inherent volatility of the type of fund

For High Yield Corporate Bond (HYCB) funds, for example, over the past 14 years we have always been able to “duck” before the HYCB fund declined even 3% off its high day.  (We do not wait for a 3% decline – we use moving averages and other techniques, which sometimes result in our “ducking” out of a HYCB fund less than 1.5% off of a temporary market top.)

Here’s a chart illustrating that our Defensive Timing system always sells after a high, and always buys after a low.

In the chart above, the down arrows illustrate Sierra "sell" signals, and the up arrows indicate "buy" signals. 

But all of our sell signals fulfill their main goal:  To protect the client's account from the possibility of further decline.  For example, the sell signal in late 1997 for this fund turned out to be a "false alarm" – within a few days the fund reversed direction again, and we had to buy back in at a slightly higher price than we sold.

But the next two sell signals kept our clients out of more extensive and deeper declines, and as a result, over the several-year period shown, our clients ended up with a better return than the buy-and-hold investor.  (And note that the years shown here were not typical for this fund, but illustrate the benefits of our daily monitoring and Defensive Timing during tough periods.)

For bond funds other than HYCB funds we allow somewhat greater swings.  And for equity funds – especially sector funds and others with high volatility – we tolerate much larger swings without reacting – and the day of executing the “sell” or “buy” signal in an equity fund may on occasion bring a significant further decline.

As just stated above,  not all of our “buy” and “sell” signals are productive.  At least 1/3 of our “sell” signals turn out to be false alarms  (i.e., after we sell, the market and fund turn back up, and we end up buying back in at a somewhat higher price than we sold).  But every “sell” signal serves its primary purpose:  To eliminate any possibility of a further decline in your account.

Similarly, not every “buy” signal results in a profit.  On occasion, the market and fund turn down shortly after we buy, and we end up selling at a small loss.  But overall, because of our daily monitoring and Defensive Timing discipline, we are never on the wrong side of a trend for very long, or for a very extended price move.

A Defensive Timing “sell” signal is different from an Asset Allocation change 

Temporary “sell” signals are normal, even in a long-term productive fund – occurring on average about twice a year under our Defensive Timing formulas.  In contrast, we may on occasion move some of your assets into a fund in a different asset category – a change in your Asset Allocation.  Also, on occasion we may “Upgrade” you to different fund within the same asset class, such as when a good portfolio manager leaves a Designated Fund or the fund underperforms its peer group for several months or quarters.

We at Sierra are very proud of our Defensive Timing system – even though it is just one portion of our overall offensive/defensive approach to investment management.  Not only have our real-money accounts placed high in national competitions sponsored by the U.S. Trading Championship and Money Manager Verified Ratings, and tracking reports by MoniResearch – but we have also been selected by well-known national firms to do timing work for them.

To summarize Sierra’s Defensive Timing^SM strategy:

·        Our Defensive Timing^SM discipline is not predictive; we simply react to actual and significant reversals in the trend of each fund.

·        Our primary goal is not to out-perform a buy-and-hold approach to the same fund, but to protect your account from sustained declines.  And thereby to keep your overall, diversified Sierra managed account on track for the long-term target returns we have discussed with you.

·        Not every Defensive Timing switch is productive.  Some “buy” signals result in a small loss, and some “sell” signals turn out to be false alarms.  But most often, we are on the right side of the market for several months or longer.

·        The amount of fluctuation we tolerate varies considerably, based on the inherent volatility of the type of fund.  HYCB funds have low volatility, for example, and thus our Defensive Timing parameters allow us to limit risk in that category to less than 3% off the high day.  In contrast, equity funds swing much more in value, so our Defensive Timing system is programmed to ignore swings of 5% to 7.5%, depending on the fund, before it can generate a “sell” signal.  On occasion a “sell” signal may be executed more than 9% off the high of a volatile equity fund.

 Cautions and Limitations:

1.  With very few exceptions (not relevant to Sierra clients), mutual funds are priced only once a day – unlike stocks – and those prices are not made available for us to analyze until well after the deadline for making switches – which is generally 11:30 a.m. Pacific Time for accounts at Schwab and First Trust/DataLynx.  In many cases, therefore, actual execution of a switch will take place one market day after the fund’s price action generates a “buy” or “sell” signal, and at a less favorable price.

2.  While Sierra believes that our investment strategy in general – and our Defensive Timing discipline in particular – can reduce the impact of sustained market declines and provide other benefits over  periods of 18 months or more, there will be intervals when any given timing system will underperform a buy-and-hold strategy.  Past performance of a particular fund or timing system, such as those used by Sierra, is no guarantee of future performance, particularly over periods shorter than 18 months.

3.  In a taxable account, each switch out of a Designated Fund (with the “wash sale” exception noted below) is a sale of the fund for income tax purposes, and any gains will be taxable as capital gains, usually at the same tax rates as ordinary income.  Long-term capital gains are generally taxed at significantly lower rates.  A sale of fund shares at a loss, preceded or followed by a second purchase of the same fund within 30 days, will be temporarily disregarded for tax purposes as a “wash sale”, and the loss will not be recognize until a subsequent sale.

·        For an investors with a taxable account, it may be helpful to ask yourself what your alternative investment strategy would be.  If it is CD’s, for example, then over the years you are very likely to be much better off with a HYCB fund timed by Sierra, or in Sierra’s HYCB Program, even after taxes.  But if you are capable of sustaining a buy-and-hold approach with an S&P 500 index fund without any “safety net” (that is, without any defensive components in your strategy), then you may want to try to hold such a fund for a year or more without timing, and perhaps you will achieve a better after-tax result.  Always ask yourself, “What is my downside?”, then ask whether you can tolerate that level of risk.

4.  Charles Schwab imposes a Short-Term Redemption (STR) fee whenever mutual fund shares are sold within 90 days of purchase (180 days for members of the public) – one reason Sierra prefers to custody most client assets at First Trust/DataLynx.  Separately, some mutual funds have STR fees triggered by sales within 90 days or other periods (Sierra seldom uses funds which impose STR fees).  On occasion Sierra’s Defensive Timing discipline and the fund’s price behavior will result in a “sell” signal occurring within 90 days of purchase, or within a fund’s STR fee period, triggering the STR fee, which will reduce net performance.

For other important Limitations and Cautions, click here.  

Click here for an illustrated graph showing the primary purpose of Defensive Timing^SM.

Click here for an illustrated graph showing "Defensive Timing^SM during a global panic.

Click here for a chart showing how Defensive Timing^SM can enhance long-term returns.

SIERRA INVESTMENT MANAGEMENT, INC.
3420 OCEAN PARK BOULEVARD, SUITE 3060
SANTA MONICA, CA 90405
310/452-1887   800/729-1467   FAX 310/452-2680

Click here to write to us: Info@SierraInvestment.com