Q: Can you give a brief history of the Stadion Tactical Growth Fund?
The Stadion Tactical Growth Fund has utilized Exchange-Traded Funds (ETF) since its inception. The fund is managed with a defined process designed to allocate toward portfolio holdings that offer desirable risk / reward characteristics. The fund has been around for over 10 years and its founder, Paul Frank, remains part of the portfolio management team. The philosophy and process has not changed.
Q: What core principles guide your investment philosophy?
The philosophy behind this fund is to participate more in rising markets and participate less in falling markets. The fund is designed to take tolerable risks via a stronger correlation in bull markets but reduce correlation and risk during weak market environments. Our securities selection process naturally tilts towards US Equity ETFs and equity markets in general, so this strategy is a US tactical equity strategy that has the flexibility to reduce its allocation to US equities when the risk/ reward characteristics of those holdings become less desirable.
Q: What is your investment process?
Generally the fund is tilted and focused more towards domestic equity type investments using ETFs, but the fund can also look for other opportunities based on prevailing market risk. The process uses Sharpe-adjusted momentum-to achieve this. Proprietary metrics based on Sharpe Ratio and security screening measure return per unit of risk. We look at that measure over a short and a longer timeframe and see how it has moved in relation to other securities to give us an indication of which offers the risk-adjusted momentum we seek. For example, if we had two securities that had the same exact return over a certain time period but one does it with less volatility, then our screening method is going to rank that security higher because it got to the same place with less risk. Alternately, we could have two securities with very similar volatility but the one with the highest return will be ranked higher by our ranking process. What occurs naturally over time is when things are going well in the market, the risk adjusted ranking process brings those ETFs that are also doing well at the same time to the top and some of those ETFs might be higher beta type issues that then find their way into the portfolio. But when risk rises in the marketplace and volatility increases those securities with lower volatility tend to rise in the rankings, finding their way into the portfolio, thus making it more defensive in its nature. The process is simple. We are looking to achieve positive returns but we want to do it while taking the least amount of risk possible to achieve favorable growth. That’s what that whole process is built around.
Q: What principles guide the ranking process?
We look for inflection points in the market to set our timeframe. For instance, if we look back at when the market dipped in July and into the first week of August but then started to rally, we would see that as an inflection point in the market. Our next step is to analyze the momentum since that day and look at a shorter timeframe possibly where things started to wane a little bit here in the last week of September, which we could use as our short timeframe. Using inflection points, we can look at risk-adjusted momentum to see how it’s behaving as risk environments change. The difference between the long and short Sharpe adjusted momentum tells us what’s doing well right now from a risk-adjusted standpoint. This guides us toward our intent of being invested in those areas where the risk-adjusted methodology fits best for us. That doesn’t necessarily mean we’re going to make wholesale portfolio changes because much of it may be adequate already, but we are certainly looking for any glaring differences. Generally, we want the portfolio to be fully invested as much of the time as possible and in the best investments possible at the right moments. The domestic equity market may dominate the portfolio most of the time but we have the flexibility to alter that allocation to bring non-correlated investments like fixed income, non-correlated equity, or commodities when they make more sense. The ranking process has been the same since the inception of the fund.
Q: Do you follow any allocation process?
Again, the majority of the portfolio is going to be allocated towards domestic equity often beginning with the broader end of ETFs and generally combined with smaller allocations to specific sectors that are high within our rankings. When risk changes within those equity markets or within our security selection process we refocus from highly correlated U.S. equity markets when the markets are behaving very favorably to reduce correlation when the equity markets are behaving poorly.
Q: How does your ranking process hold up in different market scenarios?
The whole process is built into the analysis system we look at, so what’s taking place in the markets should be reflected in what’s going on with securities that we’re evaluating. For instance, the Sharpe Ratio is made up of two components – the return component in the numerator and the volatility component in the denominator. Well, if the returns of certain securities are going up as the market is going up that’s going to be reflected in that ratio. So the securities that are rising along with the market that also have reasonable volatility are what’s naturally going to find their way into the portfolio. But, if the market in general is going down then those securities that are correlated to the markets are likely to also be declining in price which will ultimately lead to a declining Sharpe Ratio. In that situation, the higher ranked ETFs generally are declining the least or have lower volatility and lower risk, and also generally have a propensity have a lower correlation. In a sideways market what we look for are securities that might not be moving sideways like the market is, but the securities that are moving up, which shows up in the momentum of that risk-adjusted measure that we are looking at.
Q: How is your research organization organized and what drives your research process?
Our research organization includes a purely dedicated research team which consists of a portfolio analyst, portfolio management operations specialist and two dedicated quantitative computational finance analysts. Our research is dependent upon what is going on at the time, so certain projects may take precedence over others, but the processes usually vary depending on the strategy that we are looking at and evaluating at any given time.
Q: What is the decision process?
Well, it is very objective and process oriented so securities must first meet our screening process to be considered, but there may be times when we need to make a decision. That is when we rely on collective judgment of the team. All of our strategies are managed by a team approach and that’s by design. We don’t want single manager risk. Generally, Paul Frank will take the lead on the decisions regarding changes in the Tactical Growth portfolio. His suggestions are discussed among the entire portfolio management team which consists of the other portfolio managers, the lead portfolio management analyst, and the supporting analyst in order to come to a consensus among the group.
Q: How do you construct your portfolio?
The number of holdings typically in the portfolio range anywhere from 10 to 15 ETFs that have all been selected from our ranking process. The turnover varies and is completely market driven, so the portfolio turnover can be very low in a market that is sustaining with not a lot of rotation going on in terms of what is leading from a risk-adjusted momentum standpoint. However, sometimes there are more volatile markets where we end up moving in and out of things more frequently, so the turnover varies over time and is completely market driven. In terms of a benchmark, we do compare ourselves to the S&P 500 Index, but we also feel that the timeframe for comparison is very, very important because of how this strategy operates. We feel the comparison timeframe should be a full market cycle, whether that’s measured from a peak to a peak or a trough to a trough, so you can incorporate all of the different risk environments that are involved because what this fund looks to accomplish is to be properly compensated for the risk being taken. There is risk management taking place within the fund the entire time so we feel that the window for evaluating and comparing the benchmark is usually a full market cycle. What we are looking to achieve is better risk-adjusted return compared to the S&P 500 over a full market cycle. This is a fund that seeks to be fully invested most of the time so there is going to be some downside participation, but really it is about correlation, we want the correlation to be higher during favorable market environments and during unfavorable market environments our process naturally brings that correlation lower because we move more toward non-correlated holdings simply because that’s what flows to the top of the rankings.
Q: Would you highlight what risks this fund is designed to mitigate or control?
Generally we look at typical market and exposure risks in the portfolio. We view downside volatility as risk and look to control that wherever possible. Since the Tactical Growth Fund is a growth-oriented strategy, our intent is to stay invested but we want to reduce risk via the types of holdings that we have. Again, it is a natural process for those moves to occur because of how we are using a risk adjusted measure within our analysis for our selection process. Simply put, it is the security selection process that naturally morphs the portfolio over time.
