At MSCM, we employ very conservative investment precepts as the predominant guide in our investment process. Our primary objective is to make a steady and consistent return. We employ the same level of discipline and analysis to all of our strategies.
Stage One: Macro-Economic Context
We typically begin with a top down assessment of the market. This assessment is largely based upon our firm’s interpretation of extensive quantitative data. The firm prides itself on a deep understanding of key market drivers, not simply ‘headline numbers’. It is our belief that this analytical rigor has helped our firm avoid the deep losses experienced by the majority of other funds since we frequently have a strong understanding of the existing risk in the market while many others remain happily oblivious. We also utilize proprietary internal quantitative models designed to measure the overall strength of the market. From this assessment, a group of sectors will often arise as areas of interest for positions in addition to the broad market view we formulate.
Sector Weightings – Many dividend based investment managers find it sufficient to ‘underweight’ a sector that they feel will underperform in order to eek out modest outperformance of a poor performing sector. MSCM takes the stance that if we feel a sector will experience significant weakness or holds material risk irrespective of price action, we will allocate no capital to the sector – not merely ‘underweight’ it.
Stage Two: Qualification
We typically begin with seeking ways to express our view via market positioning based upon the outcome of our stage one macro-economic and sector assessment. Our initial focus will be positioning in broad based indices and sector ETF positions that align with our outlook.
Next, we will look to individual securities that may provide unique, company specific opportunities. We typically avoid positions with new issues as the underlying security since it is difficult to ascertain realistic fair value based upon a short operating history. Additionally, we attempt to reduce our exposure to potential ‘shock events’ by attempting to eliminate companies or sectors with the potential for binary headline risk such as small to mid-cap biotech companies since news events bifurcate results (win big or lose big) and can drive dramatic and unpredictable volatility.
Stage Three: Quantitative
Once pre-qualified, for valuation based strategies, we evaluate indices, sectors, and individual security candidates via our analytical valuation models as we try to understand fair value. This process employs both absolute and relative criteria for determining fair value. The core effort in our research process is to determine a realistic approximation of fair value for an index or stock, giving us a basis for where we believe there is significant buying support or selling resistance levels. We will then position the strategy to benefit if the underlying security stays above buying support or below selling resistance levels. A substantial buffer to fair value is typically utilized.
On a relative basis, we will examine valuation criteria such as price-to-earnings (P/E), price-to-book (P/B) and enterprise value-to-EBITDA (EV/EBITDA) in comparison to historic levels. We also concentrate on dividend yields – both the current and the implied yield. We know from historical price action, that dividend yields are one component that can provide solid buying support if certain yield levels are achieved.
For the Sector Rotation ETF strategy, holdings are determined through a momentum based proprietary formula which will select ETF investments based on price momentum. This strategy will also use an overlay of our macro monitor to verify that broad market momentum is a tailwind for continued price momentum.
Stage Four: Technical Analysis
Recent price action, momentum, support levels, resistance levels, key moving averages, moving average crossovers, and Bollinger bands are all included in the technical analysis context of our positioning. The result of this technical analysis process is a final decision on the position under review. We determine if (1) we have an interest in executing a position on the underlying security as well as (2) the preferred purchase / sell price level for the underlying security. This gives us a basis for selection of our targeted entry level, strike price levels for related option contracts, etc.
Stage Five: Stop Loss Discipline
Central to our philosophy is a strict sell discipline. Positions are closed if the price action triggers our stop rules or if our outlook for that index, sector, or individual company has been impacted by a news event or change in market character. There are loss trigger levels at which point any losing position, requires a full review of the investment thesis by the investment committee. If a second level is triggered, it mandates an almost certain closing of the losing position – irrespective of the investment thesis. It is critical to contain losses when they occur. We are firm believers that ‘hope is not a strategy’.