Plan B Investing
Plan B Investing means having an alternative mode of investing when plan A fails. For example, if you use index investing within a passive asset-allocation process, what do you do when that begins to fail? Do you have a plan B? At Flexible Plan, our dynamic, risk-managed approach is often the plan B that investors turn to when buy-and-hold investing falters. It is built into all of our strategies, and our strategies are available on most investment platforms, including Schwab, Fidelity, TD Ameritrade, TCA by E*Trade, and many variable annuity and retirement plan providers.
Just-In-Case Investing is a similar concept in that it also implies the use of multiple approaches. The difference is while Plan B Investing is applied, either automatically within our strategies or by investors after their present investment methodology begins to or has failed, Just-In-Case Investing refers to employing two different methodologies at the same time within a single portfolio.
With Just-In-Case Investing, each methodology is used all of the time. Each is there “just in case” the other fails. For this reason, our dynamic, risk-managed core strategies are often paired in a portfolio with passive cores that apply conventional asset allocation. When there is little volatility or the market is rallying, the latter does most of the heavy lifting. While the dynamically risk-managed portion will participate during such times, its largest burden sharing occurs during volatility-heavy, bear market declines.
Both approaches do best the earlier they are put into practice ahead of a market-disrupting event. They both assume that risk is always with us as investors and that its appearance is often unpredictable.
There are two other types of risk-managed investing that I’ll throw out there in this compare-and-contrast summary. Maybe I’ll do a separate article on each someday, but in the volatile market that we’ve lived in for more than a quarter, I think they are worth touching on now.
Fail-Safe Investing is a concept popularized by writer, politician, and investment adviser Harry Browne. In a book of the same name, Browne outlined the need to be an investor and not a speculator.
He said investing is simple. You just find the least-correlated asset classes (they move in different directions) and buy an equal amount of risk of each. This becomes your “permanent portfolio” as the allocation between the assets remains the same over time. Since the assets move differently in different markets, something will always be rallying. The strategy would be “fail-safe” as it could never completely fail (unless the assets chosen did not remain uncorrelated).
At Flexible Plan, our All-Terrain strategies employ this approach. They principally use gold, stocks, and bonds to invest in, as historically they have been the least-correlated major asset classes.
We did go Browne one better in creating our All-Terrain strategies. His “permanent portfolio” was a one-size-fits-all approach. At Flexible Plan, we created five All-Terrain strategies, each representing a different level of risk and thus suitability for various types of investors. Static and dynamically managed versions are available for conservative, moderate, balanced, growth, and aggressive investors.
Investing with Redundancy (IWR)
The final risk-management technique I want to discuss is Investing with Redundancy (IWR). Redundancy is one of the most frequently used concepts when trying to manage the risk of a process. It is used in two different manners: passive and active.
After Apollo 13 had its electrical system problem and the three astronauts had to skip the moon landing and limp back to earth, NASA’s recommended changes after the mission were for more backup equipment and processes. This is an example of employing passive redundancy. Even without these changes, if you get the chance to view an Apollo control capsule, you will be surprised by the number of redundant or backup systems.
When NASA created the space shuttle, it outdid the Apollo. Apollo had one computer with three redundancies built in. The space shuttle had five separate computers, four of which did the same calculations during all of the critical times—takeoff, descent, etc. In addition, the builders created a process that surveyed the results of all four and voted on which to follow—a process referred to as active redundancy.
The Wikipedia entry for “Redundancy” explains, “A structure without redundancy is called fracture-critical, meaning that a single broken component can cause the collapse of the entire structure. Bridges that failed due to lack of redundancy include the Silver Bridge and the Interstate 5 bridge over the Skagit River.”
How Flexible Plan applies IWR
For that reason, here at Flexible Plan, we are constantly seeking new ways to employ redundancy in our investing processes. Many are passive. For example, because our quantitative investing process is totally number dependent, we use multiple sources for the data used in our algorithms. We do this so that if one source is down or inconsistent, we can still trade our strategies. Similarly, since a major source of error can be human error, we have multiple people both to confirm trade instructions and also to implement the trades.
At the same time, our trading strategies employ active redundancy scoring systems like the NASA space shuttle example. They have multiple systems built into them to determine when to scale risk up or down and for choosing which systems to employ.
Over a year ago, we made our Quantified Fee Credit (QFC) strategies available. These strategies are all based on the Investing with Redundancy approach. Not only are they a low-cost version of many of our most popular strategies, but they provide two levels of risk management, which is where the Investing with Redundancy approach comes into play.
The QFC strategies employ our subadvised Quantified Funds to trade the strategies. Passive and active redundancy is employed within the funds. Within these funds, we utilize many different and—in some cases—redundant strategies to manage for performance and risk. At the same time, a different level of risk management is employed in allocating among the funds to effectuate our traditional strategies.
A “Classic” example of redundancy
A recent example illustrates how this redundancy can be helpful. As I wrote throughout the fourth quarter, the last strategy in that period to reduce risk was our Classic market-timing strategy. This strategy has been employed for many decades, was created for intermediate-term market declines, and usually exits well before the decline finishes its run.
Regardless of whether that turns out to be the case with respect to its latest sell signal (last Friday), we do know that at the present time it was the last of our strategies to reduce risk. It thus incurred all of the losses in 2018’s fourth-quarter correction—despite having both passive and active redundancies built into its methodology.
However, a year ago, we brought out a QFC version of Classic. Because it had two separate levels of risk management (one within the Quantified Funds and one among the funds), the results were not the same as those achieved by the old Classic strategy. Old Classic employs index-type funds that have no active management, while the QFC version uses our subadvised Quantified Funds, which are dynamically risk-managed.
The Classic strategy’s allocation to turn defensive occurred at the same time for both the QFC and non-QFC versions. Yet, the use of the Quantified Funds in the QFC version meant that the active management occurring within the Quantified Funds had already significantly moved the assets out of equities before the Classic strategy sell signal was issued.
As an example of Investing with Redundancy, QFC’s two levels of risk management proved the point and outperformed the older version of Classic. Plus the fees paid directly to us by the investor were lower with the QFC strategy.
Note, the QFC process has proven so popular that we will release four new QFC strategies next month: Self-adjusting Trend Following, Systematic Advantage, Political Seasonality Index, and a new suitability-based Dynamic Managed Core.
As we have said many times throughout our 37-year history, there are many ways to manage risk beyond a diversified, passive asset-allocation approach. That’s just one method, just as “buy and hold” is just one strategy.
Last week was fractionally positive on all of the major indexes. The Dow gained over 700 points on Friday’s jobs report, which saved the week and the 2019 year-to-date return number, which now is around 1%.
Investors are still smarting, however, from the 2018 yearly fund returns. According to Lipper, the average domestic equity mutual fund was down 7.7%, while the average international fund fell 15.5% in 2018.
Still, stocks have rallied for the third time since the current correction started during the end of last year’s third quarter. So far it has been the biggest rally of the decline, but we will have to wait and see whether this one is the start of something big.
It is probably too early for a breakout to be considered based on traditional chart readings, but you can barely see the Wagner “W” formation traced out at the lower right side of the following chart. This “W” pattern, where the second dip is higher than the first and the high point thereafter exceeds the top of the midpoint peak, has often marked the bottom of past corrections.
The economy continues in an in-between state. It has definitely slowed from last year at this time. Last week, the economic reports just barely beat out expectations (nine beating, eight trailing, and two in-line). It appeared that labor readings were great and manufacturing readings underperformed; however, taking a different perspective, most indicators were positive—just weakening.
Key recession indicators we review still suggest that a recession is more than a year away. Many analysts have pointed out that a big decline in the stock market can signal a recession. In fact, while eight of the 13 bear markets (defined as a market loss of 20% or more from recent highs) since World War II have overlapped a recession, only one of the last five near-miss bear markets (19%–20% decline) has overlapped a recession. Tune into our “Forecasting the Next Recession” webinar on Wednesday.
As previously indicated, our Classic strategy finally joined our other strategies with a sell signal. It moved into a 100% money-market position at the close of the markets on Friday (1/4). The QFC Classic strategy moved at the same time but into our Quantified Managed Income Fund (QBNDX), which has had better returns than money-market rates. Like the Quantified equity funds we were holding before Friday’s sell signal, the Quantified Managed Income Fund is dynamically risk managed.
While all of the strategies remain defensive, some have begun a bullish shift. Systematic Advantage has increased its equity position by almost 10%, while Fusion and Volatility Adjusted NASDAQ have reduced their short position, as STF did a week or so ago. Among the Market Regime indicators, All-Terrain remains supportive of stocks, while the Volatility version maintains its high-volatility reading for stocks, as has been the case since November.
The Political Seasonality Index strategy was one of 2018’s winners. As noted above, it will soon be available in a QFC version. It switched before Christmas into a bullish posture (100%) and has maintained that position. Its next sell signal is on January 14. You can see the year’s buy and sell signals on the strategies tracking page (our Political Seasonality Index is available post-login in our Solution Selector under the Domestic Tactical Equity category).
Some might think that the 4% gain by the NASDAQ might be a good indicator of a return to the good times. However, looking at the following chart with all of the index’s daily 4%-plus moves since 1995 highlighted by red dots, it’s clear that most of these big up days occur in a falling market, not a rising one. In fact, while declining environments were only 20% of the charted days, the big-move days occurred within them more than two-thirds of the time.
All the best,
PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS. Inherent in any investment is the potential for loss as well as profit. A list of all recommendations made within the immediately preceding twelve months is available upon written request. Please read Flexible Plan Investments’ Brochure Form ADV Part 2A carefully before investing. View full disclosures.