New York (HedgeCo.Net) – Probabilities Fund Management is an SEC- Registered Investment Advisor based in San Diego and they run the Probabilities Long/Short model on the HedgeCoVest platform. Joseph Childrey is the Founder and Chief Investment Officer for Probabilities Fund Management, and we recently had the pleasure of sitting down with him to get a deeper understanding of the strategy they use.
HedgeCoVest: Thank you for taking the time to speak with us today.
Joe Childrey: Thank you for the opportunity to share our investment philosophy.
HedgeCoVest: I have to say that your model is one of the more unique models in that you use an ETF-exclusive approach rather than making trades on individual stocks. How do you explain that?
JC: We believe that we can add value by using history as a guide to the future. Easier said than done, but we believe that identifying repeatable historical trends and patterns based on frequency and magnitude, gives us the edge. There are times to be in, out, leveraged or short, based on our proprietary rules and signals. We believe that the market adheres to certain political trends and seasonal patterns. By using the information from the past, there are certain outcomes that have a higher probability based on those patterns and trends.
HedgeCoVest: We are not talking about the basic “sell in May and go away” type seasonal patterns. You are talking about much deeper patterns than that I presume.
JC: The “sell in May and go away” pattern has validity to it, as the numbers don’t lie, but we look at so many other patterns such as Presidential cycles, Congressional cycles- the market performance when they are in session versus when they are on recess. My partner, Allen Shepard, PhD, a mathematician and I looked at many of the so called Wall Street anomalies and found that a few have statistical validity. These few made it into our strategy.
HedgeCoVest: And you use these patterns to determine the right times to be in the market and the right times to be out, is that correct?
JC: Yes, but it is really a two-pronged approach. Much like strategic asset allocation versus tactical asset allocation, we use a rules based model for strategic allocation and that comes from the patterns and trends. We then use technical analysis to time the entry points and exit points and look at event-driven moves.
HedgeCoVest: How does this impact the allocations since you are only using ETFs that are overall market based funds?
JC: We tend to be long or leveraged to the upside about 65% of the time, we are in cash another 30% of the time and then short approximately 5% of the time. We are leveraged approximately 20% of the time. Because we use ETFs, there is an inherent diversification and it is about timing the direction of the overall market. The leverage comes from leveraged ETFs that are levered up to 3X the S&P 500 (to achieve a 2x total portfolio exposure) or when we determine that we need to be short, we use inverse ETFs.
HedgeCoVest: What are the strengths to this approach?
JC: Because we use a quantified approach through the historical data, we try to avoid the biggest down days and move to cash when we feel the market is on dangerous ground. If you can avoid the biggest down days, you stand a much better chance of making money in the long run. The biggest down days tend to be much bigger percentage moves than the biggest up moves. We were up in 2008 and up double digits in 2011, so we think that we are on to something. We will lag during ultra-bull years like 2009 and 2013 since we are not shy about going to cash to protect principal during periods of high risk. Sometimes the market ignores these risks for short periods of time and sails higher and higher.
We believe that we can best grow wealth and protect capital by attempting to be out of the market during the time periods when there is a higher probability of downside risk and be in the market during the time periods when there is a higher probability of upside reward.
HedgeCoVest: I have used an analogy for several years about individual stocks versus the overall market. Since the vast majority of stocks move with the overall market, why try to find stocks that move up no matter what. Why look for the needle in the haystack if you can buy the whole haystack at the right time and sell it at the right time.
JC: That is pretty much our belief. We use the S&P 500 and corresponding ETFs to move in and out of the market at what we believe are the right times.
HedgeCoVest: Is there a type of market where you feel like your strategy outperforms other investment approaches?
JC: The portfolio is traded frequently and when we analyze the strategy’s live performance since inception, and review a back test of the strategy using the historical monthly returns of the Dow and S&P indices over the past 65 years, we expect the strategy to perform well in a volatile or choppy market.
HedgeCoVest: When you say that you trade frequently, how much of the portfolio is rolled over during a calendar year?
JC: We focus on five ETFs and we roll in and out of those funds every four or five days, depending upon the market conditions and what the models are telling us. In all, it probably means that the rollover rate is 600 to 700%.
HedgeCoVest: What measures do you take to reduce or eliminate risk?
JC: We trust our models to tell us when it is time to be in cash or when it is time to be short. That is how we eliminate risk.
HedgeCoVest: What are the weaknesses of the strategy?
JC: Sometimes we will find ourselves in cash when the market is going up and sometimes we will be leveraged at the wrong time, but like I said before, we trust our models and do not wing it, based on feelings or hunches.
HedgeCoVest: Do you think your strategy is completely scalable or could size restrict your ability to trade the strategy at some point?
JC: I think it is completely scalable. Because we are using extremely active large cap US ETFs, the size of the fund would have to grow tremendously for the strategy to be restricted by size or for the size to interfere with us being able to execute the trades.
HedgeCoVest: You guys have an interesting history. First, you launched in 2008 which was one of the worst years for the stock market ever and secondly, you started out as a hedge fund and then converted to a mutual fund structure.
JC: Yeah, launching in 2008 was just something that happened, but it worked out as we were able to post a positive return that year and that was net of fees. We kept the hedge fund structure until mid-December 2013 and then converted to a 40-Act fund. We felt the structure made more sense for what we were looking to do and we were able to port the track record of our audited returns from the previous structure because they were net of fees. Now we have an SEC-compliant mutual fund with a board of directors.
HedgeCoVest: And now you are on the HedgeCoVest platform and we are happy to have you on there.
JC: We are happy to be on the platform and we hope that it is as successful as we think it will be. It seems to be advantageous to everyone involved, especially the client.
HedgeCoVest: Thank you Joe. We hope so as well.