Jackass ACTIONS 20140114 For Website

Action Section
Introduction
This Action Section is a supplement to the book Jackass Investing. In this section I present specific trading strategies that exploit many of the behaviors engaged in by people who gamble their money by believing in and placing their money on the myths exposed in the book. Then in the Action Section for the final myth, Myth #20 There is No Free Lunch, I show how you can combine these trading strategies into a Free Lunch portfolio. As you learned in the book, a Free Lunch portfolio is one that produces both greater returns and less risk than conventional portfolios. The trading strategies presented in this section vary in complexity and the commitment required by you to capture their returns. While the returns from some of them can be captured simply by investing in mutual funds or ETFs that are managed pursuant to the trading strategies, others require you to actively monitor and potentially trade them on a day-to-day basis. Because of this varying complexity and my interest in making the book and this Action Section beneficial to all investors, I present two categories of Free Lunch portfolios. These are the Regular Free Lunch portfolio that incorporates all of the trading strategies, and the Simplified Free Lunch portfolio that eliminates the trading strategies that require day-to-day monitoring. The trading strategies presented in this section are by no means intended to be comprehensive. But they do represent a good cross-section of strategies that can be employed to better diversify your portfolio across multiple return drivers. This process results in true portfolio diversification (in contrast with the illusory diversification preached by conventional financial
Action Introduction 3 wisdom), and is the basis for the creation of your Free Lunch portfolio. Despite the fact that I present the historical performance of many of these trading strategies, either in this section or in the myth, that performance is often hypothetical, in that no single account may have traded pursuant to each strategy or during the period for which its performance is displayed. While many of the trading strategies were developed prior to the start of their displayed performance, others were developed more recently and their historical performance is solely the result of back-testing. Because of this the disclaimer that PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE, which you see displayed on virtually all investment marketing materials, holds true for each of these trading strategies, as it does for any investment.
Contents
Introduction ........................................................................................................ 2 Action Myth #1 Action Myth #3 Action Myth #4 Action Myth #6 Action Myth #7 Action Myth #8 Stocks Provide an Intrinsic Return ................................. 5 You Cant Time the Market .......................................... 19 Passive Investing Beats Active Investing .............. 27 Buy Low, Sell High ......................................................... 34 Its Bad to Chase Performance ...................................... 45 Trading is Gambling Investing is Safer ..................... 50
Action Myth #10 Short Selling is Destabilizing and Risky ...................... 53 Action Myth #11 Commodity Trading is Risky........................................ 57 Action Myth #12 Futures Trading is Risky .............................................. 59 Action Myth #14 Government Regulations Protect Investors ................ 64 Action Myth #15 The Largest Investors Hold All the Cards................... 67 Action Myth #16 Allocate a Small Amount to Foreign Stocks ................ 70 Action Myth #20 There is No Free Lunch ................................................ 76
Action Myth #1
We saw in Myth #1 how peoples sentiment towards buying and selling stocks, rather than actual corporate performance, dominates short-term stock performance. The trading strategy I present here is designed to capitalize on this return driver. The strategy buys the stocks of good companies when they are being shunned by others and attempts to ride prices higher as sentiment improves. Best yet, the strategy is time-tested with more than a decade of actual market performance. Because this trading strategy generally produces portfolios that contain less than 10 stocks, it is suitable for both small and large portfolios. Discovering Piotroski In 2001 I launched a market neutral equity fund that held a portfolio of about 100 U.S. exchange traded stocks each long and short and also utilized a variety of trading strategies. One of the strategies we employed was an adaptation of a trading strategy developed by Joseph Piotroski, at the time an accounting professor at the University of Chicago Graduate School of Business. Piotroskis strategy combined value measures, such as price to book ratio, with financial performance, such as profitability and cash flow. Not only did Piotroskis trading strategy perform well when tested against historical stock market data, it has continue to perform well in real-time since its release to the public more than ten years ago. Lets take a look. Piotroski Performance Piotroski tested his strategy across 21 years of historical data (1976 1996). In that back-testing Piotroskis strategy outperformed the market by an average of 13.4% per year. Those results, of course, had the benefit of hindsight. Meaning that the strategy had been developed to perform well on that
Jackass Investing Action for Myth #1
specific data. (No one develops and publishes a trading strategy that shows losing results on its back-tested data set!). When developing a trading strategy there is always an element of curve-fitting that strategy to the data set upon which it is back-tested, either intentionally or unknowingly. Because of this, backtested performance alone is an insufficient indicator of the efficacy of a strategy. Whether the strategy is valid or not, and can continue to perform after the date of its initial release, is a function of the validity of its return drivers. When we incorporated Piotroskis trading strategy into our fund, it was because we agreed with the premise behind its return driver. It actually had very little in-market performance at that time. But we were confident that the strategy could capture and profit from shifts in peoples preferences. Piotroski first published his strategy in a paper he released in June 2000. (See: Piotroski, Joseph D. "Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers." June 2000). That means that it now has ten years of in-the-market performance without the benefit of hindsight. Any concerns about the strategy having been fitted to past data dissolved with its in-market performance over the past ten years. One organization that has tracked the Piotroski strategy is the American Association of Individual Investors (AAII). The AAII is a nonprofit organization whose mission is to provide individual investors with the education and tools they need to build wealth. For a small annual subscription fee AAII provides access to financial data on thousands of stocks, tracks the performance of dozens of stock trading strategies and publishes top-quality articles on investing and personal financial management. They have compiled the monthly performance of a trading strategy based on Piotroskis method that continues to support the validity of his original research.
Action Myth #1 7 Impressively, from January 2001 through year-end 2009 the strategy produced a 29% average annualized return. As I prepared to publish this book its performance virtually exploded, bringing the average annual return to 48% by the end of 2010. The strategy produced these returns at a time when most people were merely trying to avoid substantial losses. This performance helps to confirm the research that shows that sentiment is a key driver of short-term stock performance. Figure 1 and Figure 2 display the performance of this strategy beginning January 2001 (subsequent to its publication). The returns include a cost of 4% each year to account for the transaction costs that could have been incurred in actual trading. Note 1-1: As of January 2011, transaction costs are assumed to be 0.50% per transaction.
Growth in $1,000 Allocated to Piotroski Trading Strategy On January 1, 2001

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Piotroski-based Trading Strategy Annual Returns

2001 2002 2003 2004 2005 92.65% -19.25% 145.20% 75.60% -12.16% 2006 2007 2008 2009 2010 -19.14% -5.24% 27.61% 71.62% 413.02%
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Action Myth #1 9
Piotroski Method - Concept The Piotroski trading strategy first identifies stocks that are trading at a low price relative to their book value. This often occurs because these companies have recently had poor historical performance and suffer from analyst neglect. Analysts typically prefer to track glamour companies with strong positive momentum. As a result, there is very little information regarding these companies future prospects being released in the marketplace. Piotroskis strategy then looks at the fundamentals of each company to determine its future earnings potential. This information is readily available simply by looking at its balance sheet and income statement. He assigns points to each fundamental measure to create what he calls an F_SCORE for each stock. He chose nine fundamental signals that attempt to measure various dimensions of each firm's financial condition. Based on each signal's realization, he assigned a "1" for "good" signals about firm performance or a "0" for a "bad" signal. The sum of those signals, ranging from 0 to 9, is the firm's overall fundamental signal. These nine signals measured three areas of a firm's financial condition: profitability, financial liquidity, and operating efficiency. The higher the score, the greater the likelihood the firm will earn positive future returns. The tested results, plus the results earned after the strategy was published in 2000, support Piotroskis initial intuition that certain stocks could be mispriced. This may seem obvious to you. But it wasnt obvious to academics, who for years were taught that markets were efficient and that simple trading strategies were incapable of earning returns in excess of market averages. What may have begun as academic research
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for Piotroski resulted in a trading strategy that you can use to make money trading stocks. What Piotroski has done, by starting with low price-to-book value stocks, is identify those that have been given up on by people He then identifies companies with fundamentally solid financial metrics. These are his signals that indicate a healthy company. As a result, once people also start to realize these downtrodden companies are healthy, they begin to buy the stock at depressed prices. In this way Piotroski has stacked the deck to capture the primary return driver that powers stock returns in the short-term, which is peoples enthusiasm for stocks. In this case their enthusiasm for particular stocks. Piotroski Method Specifics The following steps outline the specifics of the Piotroski trading strategy. The nine signals he defines are used to screen the initial universe of stocks to result in a portfolio of those stocks most likely to rise in price as people gain confidence in each companys financial health. Only stocks that pass all nine screens are included in the portfolio. This will yield an average of approximately four stocks each month. If you loosen up the constraints and require a stock to pass eight of the nine screens to be accepted, the portfolio will include an average of 25 stocks per month. While Piotroski began his research by looking at corporate financial data contained in the COMPUSTAT-Standard & Poor's database of financial information on publicly traded companies, we will rely heavily on data provided by the AAII. AAII's Stock Investor Pro is used to identify the stocks to be included in the Piotroski trading strategy and to update its performance. Stock Investor Pro covers a universe of over 9,000 NYSE, Amex, Nasdaq National Market, Nasdaq Small Cap, and over-the-counter stocks. To help ensure minimum liquidity
Action Myth #1 11 and financial reporting standards over-the-counter bulletin board stocks and ADRs were excluded. You can learn more about the American Association of Individual Investors at www.aaii.com. The following description of the Piotroski trading strategy is derived from the description published by AAII. AAII runs the screens for the end of each month and generally publishes the results in the middle of the following month. Piotroski first limited his universe to the bottom 20% of stocks according to their price-to-book value ratio. Price-to-book value was a favorite measure of value investors such as Benjamin Graham and his disciples who sought companies with a share price below their book value per share. In the short-run the market can overreact to information and push prices away from their true value. Because of this, measures such as priceto-book-value ratio help to identify which stocks may be truly undervalued. Valuation levels of stocks vary over time, often dramatically from bear market bottoms to bull market tops. During the depths of a bear market, many firms can be found selling for a price-to-book ratio less than one. In the latter stages of a bull market, few companies other than troubled firms sell for less than book value per share. Piotroski found that most stocks trading with an extremely low price-to-book-value were either neglected or financially troubled firms. Small, thinly traded stocks are rarely followed by analysts. The flow of information is limited for these stocks and can lead to mispriced stocks. Analysts typically ignore these stocks and tend to focus on stocks with general interest. This points out another feature of the Piotroski trading strategy. Most of the stocks selected by the initial price-to-book
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value screen are low capitalization stocks. This does not pose a problem for most individuals, but may limit investment by the larger mutual funds and hedge funds, as they may not be able to invest large amounts in many of the selected stocks. As described in Myth #15 The Largest Investors Hold All the Cards, this ability to buy and sell small capitalization stocks is an investment advantage held by smaller individuals over large institutional investors. Once the price-to-book screen has identified the 20% of stocks that are most undervalued, Piotroskis 9-point ranking system comes into play. Profitability, financial leverage, liquidity, and operating efficiency are examined using popular ratios and basic financial elements that are easy to use and interpret. Stocks that pass all nine screens are included in the portfolio. Minimum Profitability Piotroski awarded up to four points for profitability: one for positive return on assets, one for an improvement in return on assets over the last year, one for positive cash flow from operations, and one if cash flow from operations exceeds net income. These are simple test that are easy to measure. Because the requirements are minimal, there is no need to worry about industry, market, or time specific comparisons. 1. Return on Assets. Piotroski defined return on assets (ROA) as net income before extraordinary items for the fiscal year preceding the analysis divided by total assets at the beginning of the fiscal year. AAIIs Stock Investor Pro deviates by using net income after extraordinary items in its calculation. ROA examines the return generated by the assets of the firm. Piotroski did not look for high levels of ROA, only a positive figure. While the screen may not seem to be very restrictive, he found that over 40% of the low price-to-book-value stocks had
Action Myth #1 13 experienced a loss in the prior two fiscal years. Positive income is a significant event for these firms. 2. Improving Profitability. The next variable Piotroski considered looked for improving profitability. Piotroski awarded one point if the current year's ROA was greater than the prior year's ROA. 3. Operating Cash Flow. Piotroski awarded one point if a firm had positive operating cash flow. Operating cash flow is reported on the statement of cash flows and is designed to measure a company's ability to generate cash from day-to-day operations as it provides goods and services to its customers. It considers factors such as cash from the collection of accounts receivable, the cash incurred to produce any goods or services, payments made to suppliers, labor costs, taxes, and interest payments. A positive cash flow from operations implies that a firm was able to generate enough cash from continuing operations without the need for additional funds. A negative cash flow from operations indicates that additional cash inflows were required for day-today operations of the firm. 4. Accrual Accounting Check. This examines the relationship between the earnings and cash flow. A point is awarded if cash from operations exceeded net income before extraordinary items. The measure tries to avoid firms making account adjustment to earnings in the short run that may weaken long-term profitability. Piotroski feels that this element may be especially important for value firms, which may have a strong incentive to manage earnings to avoid triggering problems such as violations to debt covenants.
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Jackass Investing Action for Myth #1 In AAIIs Stock Investor Pro, Income after taxes represents income before extraordinary items so the screen looks for firms with cash from operations greater than income after taxes for the most recent fiscal year. 5. Financial Leverage. Piotroski awards one point if a companys ratio of debt to total assets declined in the past year, He defined debt to total assets as total longterm debt plus the current portion of long-term debt divided by average total assets. The higher the figure the greater the financial risk. Judicious use of debt allows a company to expand operations and leverage the investment of shareholders provided that the firm can earn a higher return than the cost of debt. Normally, the more stable the cash flow of a firm, the greater financial risk a company can assume. However, a company must meet the rules (covenants) along with the interest payments of its debt or risk bankruptcy and complete loss of control of the firm. By raising additional external capital, a financially distressed firm is signaling that it is unable to generate sufficient internal cash flow. An increase in long-term debt will place additional constraints on the financial flexibility of a firm, and will likely come at great cost. 6. Liquidity. To judge liquidity, a company earns one point if its current ratio at the end of its most recent fiscal year increased compared to the prior fiscal year. Liquidity ratios examine how easily the firm could meet its short-term obligations, while financial risk ratios examine a company's ability to meet all liability obligations and the impact of these liabilities on the balance sheet structure. The current ratio compares the level of the most liquid assets (current assets) against that of the shortest
Action Myth #1 15 maturity liabilities (current liabilities). It is computed by dividing current assets by current liabilities. A high current ratio indicates high level of liquidity and less risk of financial trouble. Too high a ratio may point to unnecessary investment in current assets or failure to collect receivables or a bloated inventory, all negatively affecting earnings. Too low a ratio implies illiquidity and the potential for being unable to meet current liabilities and random shocks that may temporarily reduce the inflow of cash. Piotroski assumed that an improvement in the current ratio is good signal regarding a company's ability to service its current debt obligations. He also indicated in a footnote that the decline in current ratio was only significant if the current ratio is near one. 7. Equity. The final capital structure element awards one point if the firm did not issue common stock over the last year. Similar in concept to an increase in long-term debt, financially distressed companies that raise external capital could be indicating that they are unable to generate sufficient internal cash flow to meet their obligations. Additionally, issuing stock while its stock price is depressed (low price-to-book) highlights the weak financial condition of the company. We screen for stocks that have maintained or reduced the number of outstanding shares during their last fiscal year. 8. Gross Profit Margin. Companies gain one point for showing an increase in their gross margin. Long-term investors buy shares of a company with the expectation that the company will produce a growing future stream of cash. Profits point to the company's long-term growth
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Jackass Investing Action for Myth #1 and staying power. Gross profit margin reflects the firm's basic pricing decisions and its material costs. Computed by dividing gross income (sales minus cost of goods sold) by sales for the same time period. The greater the margin and the more stable the margin over time, the greater the company's expected profitability. Trends should be closely followed because they generally signal changes in market competition. Piotroski zeroed in on improving gross profit margin because it serves as an immediate signal of an improvement in production costs, inventory costs, or increase in the sale's price of the company's product or service. 9. Asset Turnover. The final element in Piotroski's financial scoring system adds a point if asset turnover for the latest fiscal year is greater than the prior year's turnover. Asset turnover (total sales divided by beginning period total assets) measures how well the company's assets have generated sales. Industries differ dramatically in asset turnover, so comparison to firms in similar industries is crucial. Too high a ratio relative to other firms may indicate insufficient assets for future growth and sales generation, while too low an asset turnover figure points to redundant or low productivity assets. An increase in the asset turnover signifies greater productivity from the asset base and possibly greater sales levels.
Action Myth #1 17 Summary of the Stock Screens used in the Piotroski Trading Strategy At the start of each month run the following stock screens. The stocks that make it through all of the screens constitute the Piotroski portfolio for that month. Select stocks for which: First, The price-to-book ratio ranks in the lowest 20% of the entire AAII Stock Investor Pro database, then:
The return on assets for the last fiscal year (Y1) is positive Cash from operations for the last fiscal year (Y1) is positive The return on assets ratio for the last fiscal year (Y1) is greater than the return on assets ratio for the fiscal year two years ago (Y2) Cash from operations for the last fiscal year (Y1) is greater than income after taxes for the last fiscal year (Y1) The long-term debt to assets ratio for the last fiscal year (Y1) is less than the long-term debt to assets ratio for the fiscal year two years ago (Y2) The current ratio for the last fiscal year (Y1) is greater than the current ratio for the fiscal year two years ago (Y2) The average shares outstanding for the last fiscal year (Y1) is less than or equal to the average number of shares outstanding for the fiscal year two years ago (Y2)
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Jackass Investing Action for Myth #1 The gross margin for the last fiscal year (Y1) is greater than the gross margin for the fiscal year two years ago (Y2) The asset turnover for the last fiscal year (Y1) is greater than the asset turnover for the fiscal year two years ago (Y2)
You can track the portfolio and performance of the Piotroski trading strategy by becoming a member of AAII, which I highly recommend, at www.AAII.com.
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Action Myth #3
In addition to providing you with a usable trading strategy, this section shows how: 1. a hypothesis/concept (fading the sentiment of the most aggressive retail investors) leads to 2. collection of the data relevant to identifying the sentiment extremes, which leads to 3. a study that indicates the valid basis for a trading strategy, that leads to 4. development of the actual trading strategy to exploit the initial hypothesis Once this process is understood, it can be expanded to produce dozens of trading strategies that exploit numerous, unrelated return drivers. This is the approach my firm, Brandywine Asset Management, first developed almost 30 years ago and continues to employ today. The majority of people do not employ a systematic process when they invest their money. As a result, they react emotionally to every market move or geopolitical event. The result, as shown in the DALBAR studies, is that they dramatically underperform the average performances of the mutual funds and ETFs in which they invest. This provides us with a great opportunity to outperform those same funds. Because the majority of people are so consistent at mis-timing the market, we can use them as our George Costanza indicator and do the opposite. There are numerous measures of market sentiment. Some are quite direct. Others esoteric. In 1996 my trading was highlighted in an article in the financial weekly Barrons after I captured sizable profits from the grain market rally that
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spring. In the same article was the following comment regarding the timing indicator used by another trader. [Trader name] has developed his own set of indicators such as the number of dental operations performed on pets. They were up 100% last year, indicating a jump in the spending of disposable income. Ergo, inflation. This trader clearly did not employ the K-I-S-S (Keep It Simple Stupid) method! There were certainly more direct ways to measure investor sentiment than dental operations performed on pets. Unfortunately, a couple of years after this article was published the trader lost substantial money in the Asian markets, resulting in a total loss for him and the people who entrusted their money to him. I prefer to employ more direct measures of investor sentiment. Some of these investor sentiment measures are based on direct surveys of market participants. These include the surveys conducted by Investors Intelligence (II) and the American Association of Individual Investors (AAII). II surveys over one hundred independent market newsletters and records each advisors stance on the U.S. stock market as bullish, bearish or correction. They have applied a consistent approach to their record-keeping since they began the survey in 1963. Interestingly, when the founder of Investors Intelligence, AW Cohen, first developed the survey he expected that the best time to be long the market would be when most advisors were bullish. As we all know now, this proved to be exactly opposite the truth. The majority of advisors are almost always wrong at market turning points. The Investors Intelligence website is located at: http://www.investorsintelligence.com/. I already introduced you to the AAII. The AAII states that they arm individual investors with the education and tools they need to build wealth. One of the tools they provide is a weekly measure of the percentage of individuals who are bullish,
Action Myth #3 21 bearish or neutral on the stock market in the short-term. The AAII also surveys people on the percentage of their assets they have allocated to stocks, bonds and cash. One of the more recent measures has been developed by TrimTabs Investment Research. TrimTabs is an investment research firm focused on equity market liquidity. They develop quantitative trading models that incorporate supply and demand factors, rather than the conventional price or earnings data. TrimTabs research confirms what we learned in Myth #3, people are poor market timers and in particular, people who place money in leveraged stock market ETFs are impressively wrong in both directions. According to TrimTabs model (developed by Vincent Deluard), in the week following inflows into leveraged U.S. equity ETFs, the market falls by an annualized 13.7% and in the week following outflows the market rises by an annualized 10.3%. This creates an opportunity to develop a trading strategy based specifically on the inability of people to successfully time the market. The Sentiment Strategy - Concept Based on the TrimTabs study, I developed a sentiment-based trading strategy that takes both long and short directional positions in the U.S. stock market, depending on whether people are aggressively selling or buying stocks (through ETFs), respectively. In keeping with what we learned in Myth #3, the strategy does the opposite of what most people are doing. It buys the SPDR S&P 500 ETF (SPY) when people are bearish and buys the ProShares Short S&P 500 ETF (SH) (which attempts to produce the inverse of the S&P 500 index each day) when people are bullish.
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The Sentiment Strategy - Performance Because most inverse and leveraged ETFs began trading in the mid 2000s, flows in these ETFs started being meaningful in 2006. Because (as youll see in the strategy specifics section) the strategy requires one year of data before it can start trading, I started the track record in January 2007. This gives us four full years of performance data, including the financial crisis. I did not include interest income for the 74% of the time that the strategy is out of the market. Figure 3 and Figure 4 display the performance of the sentiment strategy compared with a long position held in the S&P 500 Index. The sentiment strategy beat the S&P 500 by about 95% in the four years ending in 2010. What is more impressive is that the sentiment strategy achieved this performance by being invested only 26% of the time. In other words, the sentiment strategy trades very little, but it trades very well. The sentiment strategy achieved a positive rate of return in 75% of the months. As you can see in the chart in Figure 4, the sentiment strategy achieves most of its gains during sharp market sell-offs - when investors are most emotional and more prone to mistakes. As a result, the sentiment strategy is a great edge against the passive long positions of your portfolio. All you need to trade this strategy are the guts to go against the crowds in times of intense market stress.
Action Myth #3 23
Performance of the Sentiment Strategy Relative to SPY (Spiders)

YEARS AVERAGE ANNUAL RETURN ANNUALIZED VOLATILITY MAXIMUM DRAWDOWN % PROFITABLE MONTHS % PROFITABLE ROLLING 12 MONTHS % PROFITABLE YEARS TIME IN MARKET SPY (SPIDERS) 4.0 -0.96% 19.60% -55.19% 56% 43% 75% 100.00% SENTIMENT STRATEGY 4.0 17.11% 17.52% -10.82% 75% 100% 100% 26.22%
Figure 3
Performance of the Sentiment Strategy Relative to SPY (Spiders)
Figure 4
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Sentiment Strategy ETF Listing
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Action Myth #3 25
Sentiment Strategy Specifics: Here are the specific trading rules of the strategy: 1. Determine level of bullishness or bearishness of investors in leveraged ETFs. Figure 5 shows the current ETF Listing for the Sentiment Strategy. Bloomberg and other data providers report ETF share data on a daily basis. For Bloomberg users, just type: FASSO Index HP <Enter> to access the historical shares outstanding of FAS (Direxion Financial Bull 3X). Yahoo! Finance also reports the latest available data by ticker. Flow is measured as change in shares multiplied by price. Of course, flows need to be adjusted by the leverage used in the ETF. For example, inflows and outflows to/from an ETF that attempts to return two times the daily return of the S&P 500 (such as the ProShares Ultra S&P 500 ETF or SSO) will get two times the weighting of those that flow into or out of a single leveraged ETF (such as SPY). Inflows into inverse ETFs are counted as outflows (from stocks). The resultant total we will call the Daily Money Flow (DMF). 2. Each day calculate the average of the past ten (10) days DMF. This is the 10dDMF. Convert the 10dDMF into a normalized score using its rolling 100-day mean and standard deviation. Normalized score is calculated by subtracting the mean from an observation and dividing
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Jackass Investing Action for Myth #3 the result by the historical standard deviation. A normalized score of 2.0 would imply that flows are two standard deviations greater than the historical mean (note that for normally distributed variables, such occurrences happen about 2.5% of the time). If the normalized score of 10dDMF is below -1.75 (which indicates very negative sentiment), buy SPY. If the normalized score of 10dDMF is above 1.75 (which indicates ebullient sentiment), buy SH (ProShares Short S&P 500) 3. Hold the position for 5 days. If the buying/selling criteria remain in effect, the 5-day hold period resets with each day the normalized score exceeds the threshold. Also, if the normalized score falls within the threshold and then exceeds the threshold again during the hold period, a new entry signal is issued, and the 5day hold period begins again.
Note 3-1: Results shown in this Action Section are slightly different than the results shown in the book due to adjustments in the strategy algorithm and the ETF list. Note 3-2: Transaction costs are assumed to be 0.10% per transaction.
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Action Myth #4
In Myth #4 I discussed that fact that the major stock market indexes were not created with the goal of maximizing returns, but with the goal of being representative. In addition, they allocate to their constituent stocks in a way that creates quirky biases in their portfolios. Because of this there are better alternatives for you to get broad stock market exposure than to place your money into the most popular stock index funds, such as those that track the S&P 500 Index. Prior to 2005 your only option would have been to create your own actively passive index fund, a significant undertaking. But today you can put money into one of the many new index funds that have been created with the intent of performing, rather than simply being representative. Index Innovation There have been numerous studies conducted that show that by focusing on some basic attributes; certain stocks may outperform others over time. For example, in Myth #1 we saw that the primary driver of stock returns long-term was corporate earnings growth. And in Myth #4 I referenced a study that established that higher dividend payout ratios (the percentage of a companys earnings that are paid to shareholders as dividends) leads to higher earnings growth. While you can develop your own stock selection methods to attempt to identify such stocks for inclusion in your portfolio, only the largest accounts will be able to diversify across the hundreds of stocks necessary to obtain true index-like diversification. Fortunately others have done this for us. Since 2005, many new indexes have been created with the goal of systematically maximizing returns by following a clearlydefined set of rules, while still following a (reasonably) lowturnover approach. We now have a selection of performance (my term) index funds based on these new indexes that can
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serve as an alternative to the representative index funds such as those based on the S&P 500. Performance index funds can be classified into three primary categories. These are Equal-Weighted, Fundamental and Efficient. Equal-Weighted indexes are described by their classification. The stocks in these indexes are held in equal allocations, so that a 1% move in any stock has the same impact on the index as a 1% move in any of the other stocks. Fundamental indexes allocate to each stock in the index based on factors such as each companys earnings, dividend growth, positive changes in analyst recommendations, buying of shares by company insiders or book value. Efficient indexes weight each stock in the index based on quantitative information such as expected returns, correlations and volatilities. The major index providers, such as S&P and FTSE, have jumped on the Performance index bandwagon. In 2002 S&P launched an equal-weighted version of its S&P 500 Index. In 2005 FTSE teamed with Research Affiliates LLC to create a series of fundamental indexes and later with EDHEC to create a series of efficient indexes. As the FTSE EDHEC indexes were only developed in 2010, there are not yet any ETFs trading pursuant to their methodologies. However, there are a number of ETFs trading pursuant to equal-weighted and fundamental indexes. The equal-weighted indexes are based on the traditional Representative indexes such as the S&P 500 and the Russell indexes. They allocate to the same stocks as those in the indexes but on an equal-weighted basis. The fundamental indexes may start out by looking at the stocks that make up one of the Representative indexes, but they ultimately select only the subset of those stocks that exhibit the characteristics that have been found to be predictive of future share price appreciation.
Action Myth #4 29 In this Action I present the performance of four Performance ETFs; one that is equal-weighted, the Rydex S&P 500 Equal Weight ETF (RSP); and three based on fundamental indexes; the PowerShares FTSE RAFI U.S. 1000 ETF (PRF), the Vanguard Dividend Appreciation ETF (VIG), and the Guggenheim Insider ETF (NFO). These funds can serve as replacements for the typical index fund(s) that people incorporate in their portfolios. Rydex S&P 500 Equal Weight ETF (RSP) The Rydex S&P 500 Equal Weight ETF tracks the performance of the equal-weighted S&P 500 Index. While this index includes the same stocks that comprise the S&P 500, and therefore is only intended to be representative, rather than seek out stocks that will outperform others, by allocating evenly to each of those stocks it does correct the flaw (in the S&P 500) whereby the biggest companies get the biggest allocation.
Performance of the Rydex S&P 500 Equal Weight ETF (RSP) Relative to the S&P 500 Total Return Index
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PowerShares FTSE RAFI US 1000 ETF (PRF) The PowerShares FTSE RAFI US 1000 Index was developed by FTSE, in partnership with Research Affiliates. FTSE, which is owned by The Financial Times and London Stock Exchange, is a company that develops market indexes. Research Affiliates is the firm founded by Robert Arnott. It was Mr. Arnott who kicked off the fundamental indexing wave with research he presented in the early 2000s. (The RAFI acronym stands for Research Affiliates Fundamental Index.) The RAFI US 1000 Index consists of 1,000 US-listed companies with the largest RAFI fundamental values, selected from the common stocks traded on the New York Stock Exchange, the American Stock Exchange and the NASDAQ National Market.
Performance of the PowerShares FTSE RAFI US 1000 ETF (PRF) Relative to the S&P 500 Total Return Index
$1,400 $1,200 $1,000 $800 $600 $400 $200 $0 PRF S&P 500 TR
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Action Myth #4 31 Vanguard Dividend Appreciation ETF (VIG) This Vanguard ETF is managed by Vanguard and tracks the Mergent Dividend Achievers Index. The Mergent Dividend Achievers Index follows U.S. listed companies that have consistently increased their annual regular dividends for at least the past ten consecutive years and have met certain liquidity screens. (Mergent is a provider of financial data that also develops and licenses equity and fixed income indexes based on its proprietary investment methodologies.)
Performance of the Vanguard Dividend Appreciation ETF (VIG) Relative to the S&P 500 Total Return Index
$1,400 $1,200 $1,000 $800 $600 $400 $200 $0 VIG S&P 500 TR
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Guggenheim Insider ETF (NFO) The Guggenheim Insider ETF tracks the performance of the Sabrient Insider Sentiment Index.1 This is an index of approximately 100 stocks that are selected (out of approximately 6,000 eligible securities) to be purchased because company insiders have been active buyers of the stock and earnings expectations have increased. Stocks selected pursuant to these factors have shown to produce above-average returns in more than a decade of back-testing. Although there are other funds based on fundamental factors that could also be selected to serve as Performance indexes in your portfolio, I am presenting NFO for two primary reasons. First, I believe in the power of legal insider information as a predictor of a stocks price, and second, the fund now has more than four years of actual in-market performance. Many of the other fundamentally-based ETFs are more recently formed.
Performance of the Guggenheim Insider ETF (NFO) Relative to the S&P 500 Total Return Index
$1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0
NFO S&P 500 TR
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Action Myth #4 33
1Joshua
Anderson, The Sabrient Insider Sentiment Index, Sabrient (October 20, 2006).
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Action Myth #6
Buy low, sell high is a great concept that fails in its implementation. As I showed in both Myth #6 Buy Low, Sell High and Myth #7 Its Bad to Chase Performance, the opposite approach is what actually works. One such opposite stock trading strategy was developed by William ONeil, the founder of Investors Business Daily. Mr. ONeil developed his strategy by looking at the characteristics exhibited by the best performing stocks prior to them posting their large gains. He identified seven key indicators for inclusion in this trading strategy. These indicators form the mnemonic CAN SLIM that spells out the name of the trading strategy. Because this trading strategy generally produces portfolios that contain less than 10 stocks, it is suitable for small portfolios. The CAN SLIM concepts were first published by Mr. ONeil in 1988 in the first edition of his best-selling book, How to Make Money in Stocks. The book is now in its fourth printing. (See: ONeil, William J. "How to make Money in Stocks: A Winning System in Good Times or Bad." 1988.) The AAII developed and tracks a version of the CAN SLIM strategy and ranks it among the leading stock trading strategies over the past ten years. Over their entire test period, from January 1998 through December 2010, the CAN SLIM trading strategy produced a 23% average annualized return. I have adjusted the returns to include a cost of 4% each year to account for the transaction costs that could have been incurred in actual trading. Figure 10 and Figure 11 present this performance. Note 6-1: As of January 2011, transaction costs are assumed to be 0.50% per transaction.
Action Myth #6 35
Growth in $1,000 Allocated to CAN SLIM Trading Strategy on January 1, 1998

$20,000 $18,000 $16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0
97 ec D D
The CAN SLIM Strategy The AAII has developed a systematic process for trading CAN SLIM based on their interpretation of the strategy as described by William ONeil. The following description, which details the criteria underlying each letter in the CAN SLIM mnemonic, is derived from this interpretation. A description of each letter in
D 98 ec D 99 ec -0 D 0 ec D 01 ec D 02 ec -0 D 3 ec D 04 ec D 05 ec D 06 ec D 07 ec D 08 ec D 09 ec -1 0
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CAN SLIM Trading Strategy Annual Returns

1998 1999 2000 2001 2002 2003 2004 23.15% 31.23% 32.73% 48.74% 15.80% 72.29% -7.64% 2005 2006 2007 2008 2009 2010 19.28% 24.53% 25.50% -14.07% 89.81% -27.31%
Figure 11. Source AAII.com
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the acronym is followed at the end of this Action by a list of the specific criteria underlying the AAII interpretation of the CAN SLIM trading strategy. C = Current Quarterly Earnings per Share: How Much Is Enough? The CAN SLIM approach focuses on companies with proven records of earnings growth but that are still in a stage of earnings acceleration. O'Neil's study of winning stocks highlights the strong quarterly earnings per share of the securities prior to their significant price run-ups. When screening for quarterly earning increases, it is important to compare a quarter to its equivalent quarter last year i.e., this year's second quarter compared to last year's second quarter. Many firms have seasonal earnings patterns and comparing similar quarters eliminates any bias arising from this seasonality. O'Neil recommends looking for stocks with a minimum increase in quarterly earnings of 18% to 20% over the same quarterly period one year ago. When examining a percentage change it is not only important to check the figures for unusually small base numbers that may distort the percentage change figures, but it is also important to check if any of the numbers in the calculation are negative. A change in sign, as in a negative to a positive, requires special consideration and may result in misleading screening results. When screening on user-defined fields such as custom growth rates, you may find it useful to include some secondary or qualifying criterion to help ensure proper screening results. In the CAN SLIM screen, positive earnings for the current quarter are required to help make the results of the growth rate calculation more meaningful.
Action Myth #6 37 Whenever you are working with earnings, the issue of how to handle extraordinary earnings comes into play. One-time events can distort the actual trend in earnings and make company performance look better or worse than a comparison against a firm without special events. O'Neil recommends excluding these non-recurring items from the analysis. The AAII screen examines growth in earnings from continuing operations only. So the first two screening filters that make up the trading strategy are: a. quarterly growth rate greater than or equal to 20%; and b. positive earnings per share from continuing operations for the current quarter.
A = Annual Earnings Increases: Look for Meaningful Growth Beyond looking for strong quarterly growth, O'Neil likes to see an increasing rate of growth. An increasing growth rate in quarterly earnings per share is so important in the CAN SLIM system that O'Neil warns shareholders to consider selling holdings of those companies that show a slowing rate of growth two quarters in row. This screen specifies that the growth rate from the quarter one year ago to the latest quarter be higher than the previous quarter's increase from its counterpart one year prior. Basically, the current quarter's growth over the past 12-month period must be better than the previous quarter's growth over the past 12-month period. In addition, the winning stocks in O'Neil's study had a steady and significant record of annual earnings in addition
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Jackass Investing Action for Myth #6 to a strong record of current earnings. The CAN SLIM system tries to identify the strong companies leading the current market cycle. The primary screen for annual earning increases that O'Neil uses is increasing earnings per share in each of the last five years. In applying this screen, we specify that earnings per share from continuing operations be higher for each year when compared against the previous year. To help guard against any recent reversal in trend, a criterion is included requiring that the earnings over the last 12 months be greater than or equal to earnings from the latest fiscal year. This group of criteria proved to be the most stringent independent filter. O'Neil also recommends screening for companies showing a strong annual growth rate of 25% or 50% over the last five years. The winning companies in O'Neil's study had a median growth rate of 21%. O'Neil specifies a minimum annual growth rate of 25% in earnings per share from continuing operations over the last five years. This criterion proved to be the second most restrictive screen when used independently. N = New Products, New Management, New Highs: Buying at the Right Time O'Neil feels that a stock needs a catalyst to start a strong price advance. In his study of winning stocks, he found that 95% of the winning stocks had some sort of fundamental spark to push the company ahead of the pack. This catalyst can be a new product or service, a new management team after a period of lackluster performance or even a structural change in a company's industry, such as a new technology.
Action Myth #6 39 These are very few qualitative factors that lend themselves to inclusion in a fully systematic trading strategy. However, the existence of a catalyst is often reflected as a jump in the stock price. ONeill recognizes this as well and emphasizes that investors should pursue stocks showing strong upward price movements. O'Neil says that stocks that seem too high-priced and risky most often go even higher, while stocks that seem cheap often go even lower. (I agree. In Myth #7 Its Bad to Chase Performance I discuss the existence and cause of market trends and in the next Action present a trading strategy that you can use to profit from them.) O'Neil's newspaper, Investor's Business Daily, highlights stocks within 10% of their 52-week high and this is the criterion AAII established for their screen. Used independently the screen allows about one-third of the companies to pass the filter. The number of companies passing will vary over the course of the market cycle. One would expect many companies to pass during a strong market expansion, while a smaller number of companies would pass during the early stage of a bear market. S = Supply and Demand: Small Capitalization Plus Volume Demand As the catalyst starts pushing the price of a company's stock up, those firms with a smaller number of shares outstanding should increase more quickly than those with a large number of outstanding shares. In his study of winning stocks, O'Neil found that 95% of the winning stocks had fewer than 25 million shares outstanding, while the median for the group was 4.6 million. In a separate study of stock market winners by Marc Reinganum, published in the September 1989 issue of the
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Jackass Investing Action for Myth #6 AAII Journal, the findings resulted in a similar conclusion and established the cut-off at 20 million outstanding shares. The Reinganum study examined the characteristics of stocks prior to their big price increase and found that the median figure of the stocks in the study was 5.7 million shares, which doubled during the two years that each winning stock was examined. This probably indicates that firms split their shares during their big price increase. What this also indicates is that the CAN SLIM trading strategy lets smaller investors take advantage of their size. Because of the small size of the companies selected by the CAN SLIM trading strategy, the largest mutual funds are effectively unable to trade in these stocks. O'Neil also feels that share buybacks, which reduce the public float of company's stock, is positive because it reduces the supply of the company's stock while boosting per share earnings. O'Neil suggests that investors consider looking at the actual "float" of the stock. The float is the number of shares in the hands of the public determined by subtracting the number of shares held by management from the number of shares outstanding. Thus AAII requires a stock to have fewer than 20 million shares available through the float in order to be considered. When examined independently, this criterion proves to be the least restrictive screen. L = Leader or Laggard: Which is Your Stock? O'Neil is not like the patient value investor looking for out-of-favor companies and willing to wait for the market to come around to his viewpoint. Rather, he prefers to scan for rapidly growing companies that are market leaders in rapidly expanding industries. O'Neil advocates buying among the best two or three stocks in a group. You should
Action Myth #6 41 be compensated for any premium you pay for these leaders with significantly higher rates of return. After identifying a strong industry, O'Neil warns against avoiding the market leaders by purchasing "sympathy" stocks that are similar but significantly cheaper when examined by factors such as price-earnings ratios and weaker price performance. These stocks often continue to languish while the market leaders continue their strong rise. O'Neil suggests using relative strength to identify market leaders. Relative strength compares the performance of a stock relative to the market as a whole. Relative strength is typically reported with a base level of zero or one in which case the base level represents stock performance equal to the market index. Numbers above the base level reflect performance above the market index, while below-market performance can be seen with figures below the base. AAII uses a base level of zero. Companies are often ranked by their relative strength performance and their percentage ranking among all stocks is calculated to show the relative position against other securities. Investor's Business Daily presents the percentage ranking of stocks and O'Neil recommends only looking for stocks with a percentage rank of 70% or better stocks that have performed better than 70% of all stocks. AAII requires the 52-week relative strength to equal or exceed 70%. I = Institutional Sponsorship: A Little Goes a Long Way O'Neil warns against selecting low-priced stocks with small capitalization and no institutional ownership, because these
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Jackass Investing Action for Myth #6 stocks have poor liquidity and often carry a lower-grade rating. O'Neil feels that a stock needs a few institutional sponsors for it to show above-market performance. Three to 10 institutional owners are suggested as a reasonable minimum number. This number refers to actual institutional owners of the common stock, not institutional analysts tracking and providing earnings estimates on stocks. Beyond looking for a minimum number of institutional owners, O'Neil suggests that investors look at the past record of the institutions. The analysis of the holdings of successful mutual funds represents a good resource for the investor because of the widely distributed information on mutual funds. AAII established a screen for stocks to have at least five institutional owners. It is difficult to strike a balance between looking for stocks with room to expand further and stocks that may be overowned. O'Neil warns that while some institutional sponsorship is required, once everyone has jumped on the stock it may be too late to buy into it. M = Market Direction: How to Determine It? The final aspect of the CAN SLIM system looks at the overall market direction. While it does not impact the selection of specific stocks and is not included in the version of the CAN SLIM strategy I present here, the trend of the overall stock market has a tremendous impact on the performance of the individual stocks you select. O'Neil focuses on technical measures when determining the
Action Myth #6 43 overall direction of the marketplace and recommends that you sell 25% of your stocks when the market peaks and begins a major reversal. Summary of the stock screens used in the CAN SLIM Trading Strategy At the start of each month run the following stock screens. The stocks that make it through all of the screens constitute the CAN SLIM portfolio for that month. Select stocks for which: The growth of earnings per share from continuing operations, as of the latest fiscal quarter (Q1) over the same quarter one year prior (Q5), is greater than or equal to 20% The growth of earnings per share from continuing operations, as of the latest fiscal quarter (Q1) over the same quarter one year prior (Q5) is greater than the growth of earnings per share from continuing operations, as of the previous fiscal quarter (Q2) over the same quarter one year prior (Q6) Earnings per share from continuing operations for the two most recent fiscal quarters (Q1 and Q2) is positive Growth in earnings per share from continuing operations over the last five years is 25% or more Earnings per share from continuing operations has increased over each of the last five fiscal years as well as over the last 12 months The current stock price is within 10% of its 52-week high
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Jackass Investing Action for Myth #6 The stock's float is less than 20 million shares The 52-week relative strength is in the top 30% of the entire database (percent rank greater than 70) There are at least five institutional shareholders
You can track the portfolio and performance of the CAN SLIM trading strategy by becoming a member of the AAII, which I highly recommend, at www.AAII.com.
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Action Myth #7
In Myth #7 we saw that buying-and-holding the S&P Diversified Trends Indicator outperformed, on a risk-adjusted basis, a buy-and-hold position in the S&P 500 TR Index. The reason for this is two-fold. One, the S&P DTI, despite trading in just 24 markets, is more diversified than the S&P 500 TR, which trades in 500. That is because the markets in the S&P DTI include interest rate markets, currencies, precious metals, grains, livestock and other commodities. They are not all subject to the same event risk and therefore their prices move more independent of each other than do the 500 stocks in the S&P 500 TR. Two, the S&P DTI is adaptive. It follows trends. When the trend in any given market is up it is long. When the trend is down it is short. The S&P 500 TR in contrast, naively holds on to long positions even when the trend is clearly down. As good as the S&P DTI is however, it does have its flaws, as were discussed in the myth. The primary flaw is that it applies different rules to the energy markets than it does to other markets. This appears to be a case of curve-fitting the strategy to the observed results. But theres an easy solution to that problem. Simply apply the strategy consistently to all markets. In this Action I will present what is perhaps the simplest possible trend following strategy, even simpler than underlying the S&P DTI. We will apply this strategy equally to all markets in the portfolio. Because this trading strategy is applied across 30 futures markets it requires $1 million for full diversification and is therefore suitable only for the largest accounts. Small accounts can however, invest in the mutual funds and ETFs presented in the Action Section for Myth #20.
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The Month-end Trend Strategy The name of this trading strategy describes its main characteristic: it takes long and short positions in each market in its portfolio based on the direction of the trend indicated by the month-end closing price of each market. Specifically, there are two components of the ETM Diversified Trend Strategy: 1. the specifics of the trend following system to be employed 2. the selection of, and allocation among, the markets to be included in the portfolio Specifics of the Trend Following System The trend following system underlying the Month-end Trend Strategy incorporates one of the simplest possible algorithms, yet it is effective in capturing longer-term trends. The system will always be long or short in each market. Heres how it works: At month-end we will compare the price of each market to that markets 250-day moving average. A moving average is simply the average of the closing prices of that market over the 250 trading days ending at month-end. If the market price at month-end is below the moving average we will either maintain our short position (if already short) or reverse our long position to a short position in that market at the close of trading on the first trading day of the following month. If the market price at month-end is above the 250-day moving average we will place an order (if not already long) to go long that market at the close of trading on the first trading day of the following month. We apply this system to a portfolio of 30 futures markets diversified across stock indexes, interest rate contracts, currencies, energy, metals and agricultural markets.
Action Myth #7 47 Market Selection and Allocation It is important to avoid the market selection bias exemplified by the inconsistent trading of energy markets in the S&P Diversified Trends Indicator. To maintain consistency, the Month-end Trend Strategy will trade a diversified portfolio of futures markets that bases its market allocations simply on the goal of producing consistent returns across a range of market conditions. As a result, we allocate to each market with the intent of creating a portfolio that is balanced across all markets, so that no single market will, over time, dominate performance. The following markets displayed in Figure 12 have been selected to provide broad portfolio diversification:
U.S. 30-yr. Bond German Bund Long Gilt (UK) Japanese Government Bond Eurodollar Euro British Pound Japanese Yen Aussie Dollar
Interest Rates Currencies Commodities Metals Stock Indexes Energy
S&P 500 DAX 30 (Germany) FTSE 100 (UK) Volatility index Crude oil Heating Oil RBOB Gasoline Natural Gas
Corn Wheat Soybeans Coffee Cocoa
Sugar Orange Juice Cotton Live Cattle Lean Hogs
Gold Silver Copper
Figure 12
The allocation to each market is designed to ensure that over time, each market will have a balanced impact on the volatility of the entire portfolio. To achieve this we allocate to each market based on the standard deviation of the daily move in the price of each market over the prior 250 days. For example, if over the past 250 trading days the Euro futures contract has
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averaged a move of $800 from one day to the next and corn has averaged $400, then we will trade one Euro for every two corn contracts. That gives us the relative allocation among all markets. Now we need to calculate the specific number of contracts to be traded in each market. This is a function of the amount of portfolio volatility we are willing to accept. As a rough rule of thumb, a million dollar account trading a total of 50 contracts across all markets will produce an average annual standard deviation of returns approximately equal to that of the S&P 500. For the purpose of calculating the performance displayed in Figure 13 and Figure 14, I targeted a return over the 20 year period 1991 2010 that was equal to the return earned by the S&P 500 during that period. Because the Monthend Trend Strategy is more diversified than the S&P 500 the back-tests show it can achieve the same annualized return of the S&P 500 but with only 52% of the S&P 500s annualized volatility. The diversification benefit has an even greater impact on the maximum drawdown. While the S&P 500 lost more than 50% of its value during the financial crisis, the Trend Strategy (which profited during the financial crisis) suffered a maximum drawdown over its entire 20 year history of less than 12%, while targeting the same annualized return as the S&P 500. This is the same trend following strategy that produced the results displayed in Figure 36 in Myth #12. While that performance, trading just five stock index futures contracts, outperformed the S&P 500 on a risk-adjusted basis (the return matched that of the S&P 500 Total Return Index while the maximum drawdown was 47% less), risk is reduced even more when the strategy is employed across 30 markets rather than just five. This simple trend-following strategy produced the following back-tested returns relative to the S&P 500 Total Return Index over the past 20 years.
Action Myth #7 49
Performance Comparison: Trend Strategy vs. S&P 500 Total Return Index
Years Average Annual Return Annualized Volatility Maximum Drawdown % Profitable months % Profitable Rolling 12-Months % Profitable years
Figure 13
S&P 500 TR 20 8.93% 14.98% -51% 63% 78% 80%
Trend Following 20 9.11% 7.81% -12% 65% 86% 84%
Performance Comparison: Month-end Trend Strategy vs. S&P 500 Total Return Index
7,000
6,000 5,000 4,000 3,000 2,000 1,000 90 92 94 96 98 00 02 04 06 08 ec D D ec ec ec ec ec ec ec ec ec ec 10
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Figure 14
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Action Myth #8
In Myth #8 I showed that simply buying-and-holding stocks in multiple industry sectors provided very little diversification value, especially in bear markets, as the sector performances are highly correlated with each other. But they are not perfectly correlated and this opens up the opportunity to trade pursuant to a disciplined strategy that attempts to identify and allocate to the strongest sectors and avoid the weakest. Schreiner Capital Management (SCM) is a registered investment advisor that provides investors with active management solutions. They have been trading client assets pursuant to sector allocation strategies since 1989. The strategy and performance presented here is an original sector allocation strategy developed by SCM and differs from the specific strategy they currently employ for their clients. Before I present the strategy rules, lets take a look at the performance of the strategy relative to that of the S&P 500 Total Return Index (Figure 15 and Figure 16).
Performance Comparison: Sector Allocation Strategy vs. S&P 500 Total Return Index
S&P 500 Total Return 12 0.21% 16.12% -51% 56% 61% 67% Sector Allocation Strategy 12 4.60% 13.35% -41% 56% 68% 67%
Years Average Annual Return Annualized Volatility Maximum Drawdown % Profitable Months % Profitable Rolling 12-Mos. % Profitable Years Figure 15
Action Myth #8 51
Performance Comparison: Sector Allocation Strategy vs. S&P 500 Total Return Index
2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0
Value of Initial $1,000 Investment
Sector Allocation Strategy S&P 500 Total Return Index
Figure 16
The performance shows that this simple momentum-based strategy outperformed a buy-and-hold position in the S&P 500 Total Return Index while suffering both lower volatility and drawdowns. Sector Allocation Strategy The SCM sector allocation strategy is a straightforward momentum-based strategy that attempts to take long positions in the strongest-performing industry sectors and avoid positions in the weakest. The strategy has been tested using Rydex mutual funds for its sector exposure, but could also likely be adapted to use other sector funds or ETFs. The portfolio as defined by SCM includes 20 separate mutual funds. While 17 of these are U.S. sector funds, the portfolio does also include two country funds and one managed futures fund.
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These 20 Rydex mutual funds are:

Symbol RYBIX RYCIX RYEIX RYFIX RYHIX RYHRX RYIIX RYKIX RYLIX RYMIX Name Basic Materials Consumer Products Energy Financial Services Health Care Real Estate Internet Banking Leisure Telecommunications Symbol RYOIX RYPIX RYRIX RYSIX RYTIX RYUIX RYVIX RYEUX RYJHX RYMBX Name Biotechnology Transportation Retailing Electronics Technology Utilities Energy Services Europe 1.25x Strategy Japan 2x Strategy Commodities Strategy
Figure 17
The basic underlying rule is to buy each mutual fund, selected from the list, when it shows a positive rate of change (ROC) in price over the prior 42 trading days. Each fund gets a 5% allocation of the cash allocated to this strategy. Once a position is entered into, it is held in the strategy for a minimum of 21 trading days. Following 21 trading days, a position will then exit if and when the ROC is negative. Note 8-1: The strategy algorithm was adjusted for results beginning January 2011, so results in the book may differ slightly from the results included in the Performance Reports on the interactive website. Note 8-2: As of January 2011, transaction costs are assumed to be 0.10% per transaction.
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Action Myth #10

As I showed in Myth #10, the ability of investors to be able to sell stocks short provides value to the overall financial markets. But short-selling also provides tremendous opportunities to the short-sellers as well. First, holding short positions in a stock portfolio can serve as a hedge to reduce portfolio losses when there are sizable market sell-offs. But short positions can also serve as a source of additional returns. By selecting stocks of poorly run companies to sell short, the short-seller will profit as other investors begin to recognize the underperformance of those companies as well and sell the stock. This collective selling will cause the stock price to fall, enabling the original short seller to buy those stocks back at a lower price. For decades short-selling was exclusively the domain of hedge funds, which reduced the risk in their long stock portfolios by also holding short stock positions. But you can now participate as well. In recent years various mutual funds have been formed that exploit the benefits of shortselling. Long-Short & Market Neutral Funds There are two categories of funds that take both long and short positions in stocks. One is the long-short fund. These funds take short positions but may retain a long market bias. An example is a fund that holds long stock positions valued at 100% of the portfolios value and short positions equal to 30% of the portfolios value. This fund is 70% net long. A true marketneutral fund attempts to more closely balance both long and short positions by dollar value, as well as other sector, capitalization and style factors. There are two primary ways to participate in a long-short or market-neutral fund. The first is to create your own. You can do this by following a trading strategy that ranks stocks in
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order of their attractiveness, but instead of simply buying those deemed most attractive; also sell short those deemed least attractive. The Piotroski trading strategy, described in the Action for Myth #1, is one method that can be used for this purpose since it ranks stocks on a scale of 0 (great to short) to 9 (great to hold long). Each month rebalance the account to hold an equal dollar amount of good stocks (such as those ranked 8 & 9) long and bad stocks (those ranked 0 & 1) short. While this approach does result in a dollar balanced long-short fund, it requires dozens or hundreds of positions each long and short and sophisticated formulas in order to effectively reduce the factor exposures. As a result, the creation of a true market neutral fund is generally suitable only for larger portfolios. The second way to participate is to put your money into a fund that takes both long and short positions. When I launched my first market neutral hedge fund in 1996 there were no mutual funds that employed market neutral strategies. At that time there were restrictions on short selling that essentially prevented a mutual fund from being market neutral. That is no longer the case today. A great source of mutual fund data is www.morningstar.com and using their free mutual fund screener results in a list of more than a dozen market neutral funds. One that stands out is the JP Morgan Research Market Neutral Fund (JMNAX). JMNAX uses fundamental analysis to create a portfolio that is both long and short approximately 150 stocks. The fund also attempts to eliminate any factor biases by being market-, dollar-, sector-, and style-neutral. This neutrality is evidenced by the funds low 0.23 correlation to the S&P 500. Figure 18 shows the performance of JMNAX relative to the S&P 500 Total Return Index (since it can serve as an alternative to a buy-and-hold position in stocks).
Action Myth #10 55
Performance of the JP Morgan Research Market Neutral Fund (JMNAX) Relative to the S&P 500 Total Return Index
$1,800 $1,600 S&P 500 TR JMNAX
$1,400 $1,200 $1,000 $800 $600 $400 $200 $0
Figure 18
There are other long-short funds that even without being truly market neutral, can add value and minimize losses during stock bear markets because of their short-selling component. The TFS Market Neutral Fund (TFSMX), which uses a purely quantitative approach to long-short stock selection, has demonstrated this ability since its inception in 2004 (Figure 19). As evidenced by its 0.43 correlation to the S&P 500, it does have slightly more market exposure than does JMNAX, but its short positions have reduced losses during losing periods for stocks.
Ju D n-0 ec 2 Ju -02 D n-0 ec 3 Ju -03 D n-0 ec 4 Ju -04 D n-0 ec 5 Ju -05 D n-0 ec 6 Ju -06 D n-0 ec 7 Ju -07 D n-0 ec 8 Ju -08 D n-0 ec 9 Ju -09 D n-1 ec 0 -1 0
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Performance of the TFS Market Neutral Fund (TFSMX) Relative to the S&P 500 Total Return Index
$1,800 S&P 500 TR TFSMX
$1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0
Figure 19
Note: 10-1: Due to limitations on availability to new investors, we have removed TFSMX from the portfolio. We have replaced this market neutral constituent with TMNFX.
ec -0 Ju 4 nD 05 ec -0 Ju 5 nD 06 ec -0 Ju 6 nD 07 ec -0 Ju 7 nD 08 ec -0 Ju 8 nD 09 ec -0 Ju 9 nD 10 ec -1 0
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Action Myth #11

In this myth I introduced you to the term structure of commodity futures contracts. The term structure is simply a phrase that refers to the relationship in prices between futures contracts that will be expiring soon and those that will not expire for months or years to come. Because each of these futures contract months trades at a price that is potentially different from the other contract months, opportunities arise to profit from these differences. One popular strategy that is employed to capture this return driver, specifically in the currency markets, is the carry trade. The carry trade opportunity is created by the fact that interest rates are at different levels in different countries. For example, while the Australian one-year interest rate (how much you would earn over the next twelve months if you purchased a one-year Australian government note today) is at 5.75%, the one-year Japanese interest rate is at 0.20%. This means that an investor who borrows the equivalent of $1,000,000 in Japan and buys a treasury note of the same value in Australia will make $55,500 over the course of the year (person pays $2,000 in interest in Japan and earns $57,500 in interest in Australia). The currency futures markets are priced to account for this differential in interest rates between countries. The futures contract for the Australian dollar one year in the future is priced approximately 5.75% below todays value of the Australian dollar. This ensures that a person cant simply buy a one-year Australian note today, sell the Australian Dollar futures contract (one-year forward) to hedge the currency risk over the next year, and pocket the 5.75% risk-free. But by being priced this way it enables a person to buy the one-year futures contract, and, if the Australian Dollar remains at the same level, profit from the fact that it will rise in price by 5.75% over the next year. This is the basis for the carry trade.
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Many hedge funds and institutional investors frequently engage in this carry trade. Because they have credit lines and other means of borrowing, they may only post collateral of a few percent of the face value of the borrowed money (certainly less than $50,000), therefore earning more than 100% on their invested funds. There is of course a risk. Currency values fluctuate. If the Japanese Yen increases in value by more than 5.55% over the course of the year relative to the Australian Dollar, then the entire profit is wiped out. That is because when the investor pays back the $1,000,000 value of Japanese Yen that he borrowed, it will actually cost 5.55% more, or $1,055,500. But despite that risk of occasional loss, over time the carry trade has produced positive returns. Until recently, the use of this trading strategy has been confined primarily to professional traders. But over the past few years ETFs have been launched that provide people with access to this strategy. One of those is the PowerShares DB G10 Currency Harvest ETF (DBV). DBV seeks to track the performance of the Deutsche Bank G10 Currency Future Harvest Index Excess Return, plus the U.S. short-term interest rate. The fund compares the three-month interest rates for each of the G10 currencies and then takes long positions in the highest-yielding currencies and short positions in the lowest-yielding currencies. Because this fund earns returns from return drivers that are distinct from those that drive the performance of most peoples portfolios, DBV can provide portfolio diversification value. Figure 20 shows the performance of the Deutsche Bank G10 Currency Future Harvest Index Excess Return, starting in 1993, the first full year of its back-test, and extending through September 2006 (reduced by 81 basis points per year to account for the fees being charged to the ETF); and DBV since its first
Action Myth #11 59 full month of trading in October 2006 through year-end 2010. The losses suffered in 2009 occurred as the carry trade unwound during the financial crisis. As a result, this strategy, while being uncorrelated to stocks for much of its history, did not provide diversification value during the 2008 financial crisis for portfolios with long stock exposure.
Performance of the PowerShares DB G10 Currency Harvest ETF (DBV)

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Figure 20
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Action Myth #12

We saw in Myth #12 how a diversified managed futures portfolio, which I also refer to as global trading, can provide more consistent returns with less risk than a portfolio comprised of long positions in stocks, bonds and real estate. This is because the commodity trading advisors (CTAs) that trade these portfolios employ a broad range of trading strategies to trade across hundreds of global stock index, interest rate, energy, metals and agricultural markets. This diversification, and the ability of CTAs to capture both up and down market trends, is also why CTAs, in the aggregate, produced profits during the 2008 financial crisis. CTAs employ a wide variety of trading strategies to capture profits from global trading. Some of the most popular methods include: Momentum (also called trend following): I discussed this in Myth #7 Its Bad to Chase Performance. The propensity for markets to trend is a key trading strategy underlying many CTAs trading programs. It was the use of trend following strategies in the currency, interest rate, stock index, energy, metals and agricultural markets that contributed to the substantial profits earned by CTAs during the financial crisis of 2008. Fundamentals: These trading strategies incorporate fundamental market data, such as the cost-of-production data used in the Marginal Cost of Production strategy described in Myth #9. While this term is also used to refer to traders who make discretionary decisions (do not follow a fully-systematic investment process), I use it to describe systematic trading strategies that base their trading decisions on data other than market prices. Fundamental futures trading strategies are
Action Myth #12 61 similar in concept to value or growth strategies used to select stocks; with the difference being that fundamentally-based futures strategies can be applied to raw commodities in addition to stock indexes. This greatly expands the diversification possibilities. Relative Value, Yield Curves and Cross-rates: These strategies all look at the relationship between or among two or more markets to signal trading opportunities. A relative value strategy may look at the prices of different futures contract months for example, to determine that one contract should be sold while another be purchased. Yield curve strategies may buy long-term interest rate contracts and sell short short-term interest rate contracts in the expectation that the yield curve will steepen (short-term rates will rise in relation to long-term rates). Cross-rates refer to the relationship among various currencies. A trading strategy may buy the Euro while selling the Japanese Yen (the currency carry trade described in Action #11 utilizes cross-rate trading, but Ive defined that as a separate trading strategy). Relative value strategies are similar in concept to market neutral strategies trading in stocks, where some stocks are held long while other stocks are sold short. A key benefit of futures trading is that it allows a trader to develop and incorporate dozens, or even hundreds, of different trading strategies that can be applied across a hundred or more global markets. While some CTAs specialize in a specific style of trading (trend following being the most popular), there are many CTAs that also diversify across both multiple trading strategies and global markets. As a result, in creating the Free Lunch portfolios that will be presented in the Action section for Myth #20, I recommend a significant allocation to these global trading strategies in any properly diversified portfolio. (DISCLOSURE: although my firm, Brandywine Asset Management, has experience trading in equities, private
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equity, mutual funds and ETFs, today our focus is solely on futures trading. While we made this decision precisely because we believe in the value futures trading can bring to a portfolio, this focus may also create a bias in our belief in the necessity of including managed futures in any truly diversified portfolio). You can place money with a CTA either in an individually managed account or fund. A managed account often requires at least $100,000, and in many cases, more than $1,000,000 to open. The high minimum investment level of the managed account is required in order for the CTA to have enough assets to fully diversify the account across a wide range of futures markets. In contrast, managed futures funds, also called commodity pools, combine peoples money into a single pooled account. Unfortunately, most commodity pools are private and limited to Accredited Investors only. This also means that the funds cannot be publicly marketed; people need to find the commodity pools on their own or be introduced to their managers through a direct relationship. Most of these private commodity pools also require relatively high initial investments of $100,000 or more. However, in recent years a number of commodity pools have publicly registered, enabling people to make initial investments of as little as $1,000. A few of the public funds available include: Altegris Managed Futures Strategy O (MFTOX) MutualHedge Futures Strategy C (MHFCX) TFS Hedged Futures Fund (TFSHX) Grant Park Managed Futures Strategy C (GPFCX) Note 12-1: Due to limitations on availability to individual investors, we have replaced MFTCX with MFTOX.
Action Myth #12 63 In the Action section for Myth #20, I recommend a significant allocation to these four funds or, alternatively, privately managed accounts or funds that you can find through the resources listed below, to provide your portfolio with valuable global trading diversification. Additional information on CTAs providing managed accounts and private pools can be found at the following sources: www.albourne.com: Albourne is a consultant, online community and database provider to professional and private investors. www.autumngold.com: is a database provider specializing in CTAs. The web site provides free access to CTA profiles and performance information. www.barclayhedge.com: BarclayHedge is one of the oldest providers of CTA data, having been founded in 1985, and is the developer of the BTOP 50 CTA index I presented in Myth #12. In addition to its database services BarclayHedge provides consultation to individuals and professional investors. www.iasg.com: Institutional Advisory Services Group assists clients in selecting CTAs that best match each clients risk tolerance and expected rates of return. The IASG website provides access to a comprehensive database of CTAs and hedge funds. www.managedfutures.com: This is part of Altegris Group, the manager of the Altegris Managed Futures Strategy Fund mentioned previously. Altegris specializes in helping investors discover and access managed futures programs and other alternative investments. The web site contains access to a database of CTAs.
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Action Myth #14

Myth #14 stresses that investors should not expect government regulations to protect them from bad investments. I also mention Alfred Winslow Jones and how the term hedge fund was derived from the fact that he created the first fund that hedged its long stock positions with offsetting short positions, thereby creating a hedged fund. In this Action I will present a description of what due diligence is and provide you with some guidance that you should follow when evaluating an investment opportunity. Investment Due Diligence Holly Miller, founder of Stone House Consulting and co-author of the book The Top Ten Operational Risks: A Survival Guide for Investment Management Firms and Hedge Funds, is an expert on the practice of investment manager due diligence. Due diligence is the process of asking about, and understanding, the risks inherent in investing with an investment manager or even a single investment. She has provided the following advice regarding due diligence. In general, the industry refers to two types of due diligence that can be performed: investment due diligence and operational due diligence, with the latter essentially including everything that is not directly related to investment decisionmaking. Many investors erroneously believe that each type of due diligence can be performed independent of the other. Yet without knowing about a managers approach toward investing, it is impossible to assess whether the manager has sufficient operational, compliance and IT infrastructure to support the investment process. Likewise, without an understanding of the managers operational processes, investors cannot evaluate whether there are adequate controls on the managers investment and trading activities.
Action Myth #14 65 There is no single checklist that an investor can follow to ensure he or she is asking an investment manager all the most important questions. Depending on the answers received, follow-up questions are often warranted. For example, if a manager indicates they will not invest more than a specified percentage of a portfolio in a given sector or industry, the prudent investor will follow up by asking, How do you monitor that? What tools to you use? How often do you check? Do you have a tolerance? Have you ever violated this restriction? Was it intentional or inadvertent? How did it happen? How did you find out you had made the error? Due diligence should always be performed before making an investment. Yet ongoing due diligence is necessary to ensure appropriate controls remain in place and that the manager has adapted operational processes, systems and compliance oversight based on regulatory changes, new product introductions, staff turnover and market dynamics. At a minimum, investors should revisit all due diligence reviews of their managers on an annual basis and in some instances more frequent reviews will be appropriate. The devil is in the details and there is no easy short-cut to the process. It is possible, though, to conduct due diligence in a way that seeks to readily identify red flags that would discourage the manager from investing. Why continue to do your homework on a manager you would avoid? Once enough red flags are encountered, there is no need to complete an exhaustive due diligence review. Instead, these flags signal that it is time to move on to another potential opportunity. So ask critical, deal-breaker questions early in the process. For this reason, most investors begin the due diligence process on the investment side. If the managers investment approach, philosophy and decision-making process as well as the managers track record are insufficiently attractive, there is
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no point conducting any sort of operational due diligence review. Once a person has made the decision to pursue any investment, they can then follow some basic Q & A guidelines. In the United States, professional investment managers are generally required to register either with the SEC or the CFTC (Commodity Futures Trading Commission). These organizations provide investors with some guidelines to follow. You can see them at http://investor.gov/ask-questions/ and http://www.nfa.futures.org/nfa-investor-information/index.html
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Action Myth #15

In June 2007, Roger Ibbotson, Zhiwu Chen and Wendy Hu published a research paper titled Liquidity as an Investment Style. In this paper they showed that less liquid stocks, those that trade few shares relative to their earnings or shares outstanding, outperform more liquid stocks. While you can create your own portfolio of less liquid stocks by screening stock databases to find those that have low trading volume relative to their earnings and capitalization, you can now also invest in mutual funds that do this for you. Zebra Capital Management was founded in 2001 by Roger Ibbotson and Zhiwu Chen and they launched a series of products based on their Liquidity Return Strategy in 2009. In 2010 Zebra partnered with American Beacon Advisors to launch two mutual funds based on this strategy. Those funds, the American Beacon Large Cap Equity Fund (AZLPX) and the American Beacon Zebra Small Cap Equity Fund (AZSPX), began trading in June 2010. Although these two funds have short performance histories, the research results displayed in Myth #15, coupled with the back-tested results shown in Figure 20 for the strategy (combining both small and large capitalization stocks) prior to the start of trading in the mutual funds, indicate that they could outperform the market averages by a few percentage points per year. Because these are new funds they also have only a few million dollars each in assets. But if their research results is any guide, these two funds could grow in size quite rapidly as their performance takes hold.
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Back-tested Performance of the Liquidity Strategy Used in AZLPX and AZXPX

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Figure 21
Figure 22 and Figure 23 display the actual performance of each fund (beginning in June 2010).
Action Myth #15 69
Performance of the American Beacon Zebra Large Cap Equity Fund (AZLPX)
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Performance of the American Beacon Zebra Small Cap Equity Fund (AZSPX)
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Action Myth #16

In Myth #16 I showed that simply buying-and-holding stocks that are traded on exchanges or whose headquarters are based in different countries provided very little diversification value, especially in bear markets, as the country performances are highly correlated with each other. But they are not perfectly correlated and this opens up the opportunity to trade pursuant to a disciplined strategy that attempts to identify and allocate to the stocks domiciled in the strongest countries and avoid the weakest. In Action #8 I presented a trading strategy developed by Schreiner Capital Management (SCM), a registered investment advisor, which followed a momentum-based strategy of buying sector mutual funds that showed positive price momentum. In this action I present a second strategy developed by SCM to trade country-specific ETFs. Before I present the strategy rules, lets take a look at the performance of the strategy relative to that of the MSCI All-World ex-USA Index (Figure 24 and Figure 25). This performance has been adjusted to reflect commissions of $0.01/share.
Action Myth #16 71
Performance Comparison: International Allocation Strategy vs. MSCI All-World ex-USA Index
MSCI All-World ex-USA 11 1.39% 19.21% -59% 56% 62% 64% International Allocation Strategy 11 8.91% 15.74% -33% 52% 66% 64%
Years Average Annual Return Annualized Volatility Maximum Drawdown % Profitable Months % Profitable Rolling 12-Mos. % Profitable Years
Figure 24. For the period January 2000 through December 2010
Performance Comparison: International Allocation Strategy vs. MSCI All-World ex-USA Index
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Figure 25. For the period January 2000 through December 2010
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The performance shows that this simple momentum-based strategy outperformed a buy-and-hold position in the MSCI AllWorld ex-USA Index while suffering both lower volatility and drawdowns. International Allocation Strategy The SCM International allocation strategy is a straightforward momentum-based strategy that attempts to take long positions in the strongest-performing country ETFs and avoid positions in the weakest. The portfolio as defined by SCM includes 25 separate ETFs.
Action Myth #16 73 These 25 ETFs are:

Symbols ECH EPI EWA EWC EWD EWG EWH EWJ EWL EWN EWO EWP EWQ EWS EWT EWU EWW EWY EWZ EZA FXI ILF RSX THD TUR
Figure 26
iShares MSCI Chile Investable Mkt Index WisdomTree India Earnings iShares MSCI Australia Index iShares MSCI Canada Index iShares MSCI Sweden Index iShares MSCI Germany Index iShares MSCI Hong Kong Index iShares MSCI Japan Index iShares MSCI Switzerland Index iShares MSCI Netherlands Invstbl Mkt Index iShares MSCI Austria Investable Mkt Index iShares MSCI Spain Index iShares MSCI France Index iShares MSCI Singapore Index iShares MSCI Taiwan Index iShares MSCI United Kingdom Index iShares MSCI Mexico Investable Mkt Index iShares MSCI South Korea Index iShares MSCI Brazil Index iShares MSCI South Africa Index iShares FTSE China 25 Index Fund iShares S&P Latin America 40 Index Market Vectors Russia ETF iShares MSCI Thailand Invest Mkt Index iShares MSCI Turkey Invest Mkt Index
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The basic underlying rule is to buy each ETF, selected from the list, when it shows a positive rate of change (ROC) in price over the prior 42 trading days. Each fund gets a 4% allocation of the cash allocated to this strategy. Once a position is entered into it is held in the strategy for a minimum of 21 trading days or until the ROC turns negative.
Frontier Markets
In addition to employing a country allocation strategy, there is one other area where a person can obtain some portfolio diversification by placing money in stocks of other countries. There are three levels of classification commonly used by investment professionals to describe the status of the markets of various countries. Developed countries, those such as the United States, Germany and Japan, are well established and very liquid. Emerging markets, such as Brazil, Russia and Mexico, have lower trading activity and less well established regulations than do the developed market countries. The final classification, which refers to the countries with the smallest stock market capitalizations and liquidity, are referred to as Frontier markets. These include countries such as Vietnam, Pakistan, and Jordan. Although the stock markets of frontier markets are subject to the same emotional price moves as those of both developed and emerging markets, they do tend to be slightly less correlated to those markets. This is evidenced by the 0.64 correlation of the frontier markets to the developed markets and the 0.59 correlation of the frontier markets to the emerging markets. In contrast, the developed markets and emerging markets are 0.92 correlated with each other over the same period.2 Because of this lower correlation we are including a frontier markets mutual fund in our portfolio. This is the Guggenheim Frontier Markets ETF (FRN). FRN has approximately a 95% overlap with the MSCI EAFE Markets Index.
Action Myth #16 75 Note 16-1: The strategy algorithm was adjusted for results beginning January 2011, so results in the book may differ slightly from the results included in the Performance Reports on the interactive website. Note 16-2: As of January 2011, transaction costs are assumed to be 0.10% per transaction.
Indexes and period used in the correlation calculations are the monthly returns of the MSCI Frontier Markets Index, MSCI Emerging Markets Index and MSCI All-World ex-USA Index for the period June 2002 through December 2010.
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Action Myth #20

There is a free lunch in investing. It is the use of true portfolio diversification. In this final (and most important) Action I will show the specific trading strategies that combined to create the performance of the Free Lunch portfolios presented in Myth #20. These trading strategies, many of which have been described in detail throughout this Action section, are based on and provide exposure to more than two dozen separate return drivers. As a result, unlike the composition of the Conventional portfolio displayed in Myth #20, the Free Lunch portfolios provide you with true portfolio diversification. In order to provide model portfolios that can be used by a wide range of investors, I have developed two types of Free Lunch portfolios for you to select from; simplified and regular. The only difference between the two is: the simplified portfolio invests only in mutual funds and ETFs, and does not trade them on an active basis. the regular portfolio also includes individual stocks and trades those as well as some of the ETFs.
In addition, each of the two portfolio types has the ability to employ one of three levels of volatility: Conservative: (this is the regular Free Lunch portfolio) Moderate: Free Lunch MR (MR stands for moderate risk. This portfolio matches the historical volatility of the Conventional portfolio) Aggressive: Free Lunch AR (AR stands for aggressive risk. This portfolio matches the historical volatility of the S&P 500)
Action Myth #20 77 Before I describe the Free Lunch portfolios in detail, lets take a look at the constituents of what conventional financial wisdom considers being portfolio diversification (Figure 27).
Conventional Portfolio Constituents

Real Estate U.S. High Yield Bonds Cash Large Cap U.S. Stocks
Aggregate U.S. Bonds
Emerging Markets Stocks Developed World Stocks
Mid Cap U.S. Stocks Small Cap U.S. Stocks
Figure 27. The composition of the Conventional portfolio was partially determined by looking at the allocations made by target-date funds with approximately 20 years until retirement.
Knowing what we do now, after the facts presented in Myth #16 Allocate a Small Amount to Foreign Stocks, Myth #17 Lower Risk by Diversifying Across Asset Classes , Myth #18 Diversification Failed in the 2008 Financial Crisis, and of course Myth #20 There is No Free Lunch, we can see that the Conventional portfolio is a highly concentrated, non-diversified, risky portfolio. As described in Myth #20, virtually all of its returns are dependent on just three return drivers. In stark contrast, the Free Lunch portfolios are much more properly diversified, as illustrated in Figure 28.
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Free Lunch Portfolio Diversification

Ags - Relative Value Ags - Fundamentals Ags - Momentum
Large Cap - Static Long

Mid Cap - Static Long
Small Cap - Static Long Developed World Emerging Markets

Aggregate U.S. Bonds
Metals - Relative Value Metals - Fundamentals Metals - Momentum

Energy - Relative Value Energy - Fundamentals Energy - Momentum
High Yield
Stock Ind - Relative Value Stock Ind - Fundamentals Stock Ind - Momentum
Int Rates - Yield Curves Int Rates - Fundamentals Real Estate - U.S.
Equal-Weighted Large Cap

Ind Corp Fundamentals
Int Rates - Momentum
Dividend Increases Insider Sentiment
Currency - Cross-rates Currency - Fundamentals

Currency - Momentum
Selective Small-cap Stocks Selective Growth Stocks Large Cap Liquidity Small Cap Liquidity
Currencies - Carry Trade
Sector Timing Market Timing - Country
Credit & Equity Arbitrage
Frontier Markets
Long International Bonds Market Neutral Long-Short
Market Timing - Inv Sent
Figure 28. Use controls at bottom of frame to enlarge pie chart.
A listing of each constituent and the percentage allocated to it in the Free Lunch portfolios is provided in Figure 29. This table also includes a listing of the actual investments you can make to replicate the performance of the Free Lunch Portfolios, as well as, if applicable, the number for the myth in which the trading strategy underlying the investment was introduced. You will notice that the last 18 listed trading strategies are related to Myth #12. These are the global trading strategies that can be accessed through investments in managed futures accounts and funds. Although 18 separate return drivers are identified, gaining exposure to these can be as simple as investing in managed futures mutual funds (for smaller portfolios) or private accounts (for larger portfolios). I identify these later in this Action.
Action Myth #20 79
Exposure to Each Return Driver/Constituent of the Free Lunch Portfolio

Constituent Cash Large Cap - Static Long Mid Cap - Static Long Small Cap - Static Long Developed World Emerging Markets Aggregate U.S. Bonds High Yield Real Estate - U.S. Equal-Weighted Large Cap Ind Corp Fundamentals Dividend Increases Insider Sentiment Selective Small-cap Stocks Selective Growth Stocks Large Cap Liquidity Small Cap Liquidity Sector Timing Market Timing - International Frontier Markets Long International Bonds Long-Short Market Neutral Market Timing - Inv Sent Credit & Equity Arbitrage Currencies - Carry Trade Currency - Momentum Currency - Fundamentals Currency - Cross-rates Int Rates - Momentum Int Rates - Fundamentals Int Rates - Yield Curves Stock Ind - Momentum Stock Ind - Fundamentals Stock Ind - Relative Value Energy - Momentum Energy - Fundamentals Energy - Relative Value Metals - Momentum Metals - Fundamentals Metals - Relative Value Ags - Momentum Ags - Fundamentals Ags - Relative Value Allocation 0.00% 1.00% 1.00% 1.00% 1.00% 3.00% 4.00% 4.00% 10.00% 1.00% 1.00% 1.00% 1.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 3.00% 4.00% 5.00% 5.00% 7.00% 0.00% 3.00% 3.00% 0.90% 2.10% 2.75% 1.65% 1.10% 2.75% 1.83% 0.92% 1.75% 1.05% 0.70% 2.00% 1.20% 0.80% 3.75% 2.25% 1.50% Investment SPY MDY IJR CWI VWO AGG JNK VNQ RSP PRF VIG NFO Piotroski Strategy CAN SLIM Strategy AZLPX AZSPX Trade Funds Int'l ETF Strategy FRN BWX TMNFX JMNAX.lw Trade SPY & SH DBV Myth
Also included in Conventional portfolio
4 4 4 4 1 6 15 15 8 16 16 10 10 3 14 11 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12
Global Trading Allocations can be made to managed futures accounts, private funds or mutual funds, as described in the following section.
Figure 29
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Brief Description of the Constituents of the Free Lunch Portfolios That Are Not Separately Described in an Action
Large Cap Static Long: SPY is an ETF that tracks the mainstay of most peoples portfolios, a long position in the stocks that make up the S&P 500. Mid Cap Static Long: MDY is an ETF that tracks the performance of the S&P 400 Mid-cap Index. Small Cap Static Long: IJR is an ETF that tracks the performance of the S&P 600 Small-cap Index. Developed World: CWI is an ETF that tracks the performance of the MSCI All-World (ex-USA) Index. This fund provides long exposure to approximately 800 stocks in 22 developed countries (such as Germany, Japan, and the U.K, but not the USA). Emerging Markets: VWO is an ETF that tracks the performance of the MSCI Emerging Markets Index. This fund provides long exposure to approximately 700 stocks in 21 emerging countries (such as China, Brazil and Russia). Aggregate U.S. Bonds: AGG is an ETF that tracks the performance of the Barclay Aggregate Bond Index. This fund provides exposure to more than 600 bonds. High Yield: JNK is an ETF that tracks the performance of the Barclay High Yield Very Liquid Index. This fund provides exposure to approximately 200 bonds. Real Estate U.S.: VNQ is an ETF that tracks the performance of the MSCI U.S. REIT Index. This fund provides exposure to approximately 100 REITs.
Action Myth #20 81
Description of the Constituents of the Global Trading Strategies Included in the Free Lunch Portfolios
In Action #12, I provided a brief description of the different global trading strategies listed in the preceding table. There are many more trading strategies that may fall outside of the classifications listed in the table. There are also other methods of obtaining the global trading diversification in the Free Lunch portfolios in addition to investing with CTAs (which I described in Action #12). But my experience with global trading is through the use of futures contracts, which is why I recommend managed futures as the source of global trading diversification in the Free Lunch portfolios. The key is to make sure that your portfolio contains a significant allocation to trading strategies that produce returns that are independent of each other. Managed futures (CTAs) provide this diversification value. (DISCLOSURE: As I disclosed in Action #12, although my firm, Brandywine Asset Management, has experience trading in equities, private equity, mutual funds and ETFs, today our focus is solely on managed futures trading. While we made this decision precisely because we believe in the value futures can bring to a portfolio, this focus may also create a bias in our belief in the necessity of including managed futures in any truly diversified portfolio). Exposure to the global trading of currencies, interest rates, stock indexes, energy, metals, and agricultural markets described in this Action can be obtained in three different ways. One is to identify individual funds or managers that trade pursuant to each of the various trading strategies represented in the global trading portion of the Free Lunch portfolios and invest with them. The Free Lunch portfolio does contain one such fund, DBV, which utilizes the currency carry trading strategy described in Action #11. But there are few other funds available to smaller investors that pursue
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individual global trading strategies, rendering this approach problematic. A second approach to gain exposure to the global trading strategies is to establish the necessary brokerage accounts, research and develop the strategies, and then trade them yourself. I outlined one such marginal cost of production trading strategy in Myth #9, and a simple momentum (also called trend following) trading strategy in Action #7. But this second approach is completely unrealistic for all but the most well-capitalized and experienced investors. That is because global trading in more than 100 markets (which is what is represented in the Free Lunch portfolios) employing dozens of trading strategies, is a professional pursuit. While todays technology allows some strategies, such as the momentum strategy, to be executed by experienced traders on a part-time basis, the full deployment of a diversified mix of global trading strategies requires a full-time commitment and millions of dollars in capital. Its not as simple as tracking a single trading strategy in stocks, such as the Piotroski trading strategy described in Action #1. A third approach, and the one I recommend for the vast majority of investors, is to invest with one or more CTAs who trade a broad range of global markets pursuant to a wide variety of trading strategies. (Of course, as disclosed previously, you must consider my bias, as this is the focus of my firm.) There are hundreds of CTAs that in the aggregate provide significant global trading diversification. I provide a short list of services that provide information on these CTAs at the end of Action #12. You can invest directly with these CTAs in either managed accounts (generally requiring up to a million dollars or more to obtain full diversification) or funds (which allow substantially smaller minimum investments as they pool your money with other investors). While most futures funds are private (meaning they cannot be publicly advertised, but if you
Action Myth #20 83 find them, they are often open to new investors), another option has recently become available. As I mentioned in Myth #12, there are mutual funds that employ the services of multiple CTAs. For purposes of estimating the allocations to the various global trading strategies in the Free Lunch portfolio, I assume that the investor makes an equal allocation of 8% of their portfolio to each of four managed futures mutual funds. These are the MFTOX, MHFCX, TFSHX and GPFCX funds. While this approach enables you to invest pursuant to the Free Lunch portfolio, it is unable to be used in the Free Lunch MR and Free Lunch AR portfolios. I will explain why, and how you can do so, in the following section.
The Leveraged Free Lunch Portfolios

The Free Lunch MR and the Free Lunch AR portfolios hold the same constituents as the regular Free Lunch portfolio, but with an additional allocation to the global trading managed futures component. This additional allocation is made possible without the use or cost of borrowed money. That is because managed futures investors are able to use notional funds to increase their exposure. Heres how it works. The typical managed futures account is required to hold cash as a security deposit to maintain its positions. Although this is also referred to as a margin requirement, it is different than using margin to leverage a stock position. There is no borrowing involved, nor interest required to be paid. A gold futures contract, for example, obligates the buyer of that contract to purchase 100 ounces of gold at a specified future date (this is why its called a futures contract). The buyer can sell that contract prior to that future date, thereby eliminating the obligation to actually purchase the gold. In fact, this is what occurs in the majority of futures transactions. Because the buyer never actually owns the gold, only an obligation to
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purchase the gold at a future date, there is no requirement to pay for the gold (or borrow money to pay for the gold). Instead, the futures exchange upon which the gold contract is traded requires the buyer to post money as a good faith security deposit, or margin. The amount of the margin deposit varies, but in a managed futures account with approximately 10% annualized volatility, a reasonable rule of thumb is that the total margin requirement to maintain all the positions in the account is approximately 10% of the account value. As a result, if the account value is $1,000,000 an investor may actually deposit only $250,000, an amount that is sufficient to cover the $100,000 margin, plus potential losses of 15%. The remaining $750,000 is considered to be notional funds. Understanding this, it is easy to see how a person who invested $1,000,000 could simply instruct the futures manager to trade the $1,000,000 as if it were a higher level. In the case of the Leveraged Free Lunch portfolios, all allocations would remain the same to each of the other portfolio constituents, with the exception of adding notional funding to the managed futures accounts that execute the global trading strategies. Figure 30 shows the increased allocation from the portfolio to the global trading managed futures accounts, that is required for each of the two Leveraged Free Lunch portfolios.
Allocations Required to be made to Global Trading in Each of the Three Free Lunch Portfolios
Portfolio Free Lunch Free Lunch MR Free Lunch AR Allocation to Global Trading 32% 48% 66% Increase 0% 16% 34%
Figure 30
Action Myth #20 85 The investor would still maintain the same 68% allocation to all other portfolio constituents. While investors in the Free Lunch portfolio can use the four managed mutual funds referenced in this Action to get their Global Trading exposure, those funds do not allow a person to use notional funding. Therefore, investors desiring to create one of the Leveraged Free Lunch portfolios must do so by opening an individual managed account, or by investing in a private managed futures fund, that allows notional funding. Because the minimum investment necessary for a manager to properly diversify a managed account can exceed $1,000,000, this option is not available to smaller investors. There are, however, a number of managed futures funds that do provide investors with the ability to invest substantially smaller amounts in a fund class that is traded at a higher leverage level, thereby making those funds suitable for inclusion in one of the Leveraged Free Lunch portfolios. The chart and table below illustrate the historical, back-tested performance of the Free Lunch, Free Lunch MR and Free Lunch AR portfolios compared with the Conventional portfolio. The results shown in the chart and table below are based on the portfolio compositions (constituents and weights) outlined in the book. The historical back-tested results of the current Free Lunch portfolio and current Simplified Free Lunch portfolio will vary due to the changes in the composition (constituents and weights) of the portfolios as shown in Figure 29 and Figure 33.
86
Performance Comparison: Free Lunch Portfolios & Conventional Portfolio

70,000
Free Lunch AR
60,000
Free Lunch MR Free Lunch Portfolio Conventional Portfolio
50,000 40,000
30,000 20,000 10,000
Figure 31
Performance Comparison of Free Lunch Portfolios to Conventional Portfolio and S&P 500 TR Index
Free Free ConventFree Lunch Lunch S&P 500 ional Lunch MR AR TR Index Portfolio Portfolio Portfolio Portfolio Years 30 30 30 30 30 Average Annual Return 10.54% 9.91% 11.62% 12.66% 14.77% Annualized Volatility 15.48% 11.49% 9.07% 11.49% 15.48% Maximum Drawdown -51% -44% -22% -21% -20% % Profitable Months 62% 66% 65% 60% 57% % Profitable Rolling 12-Mos. 78% 80% 96% 93% 92% % Profitable Years 80% 77% 93% 93% 93%
Figure 32
Action Myth #20 87
The Simplified Free Lunch Portfolios

Several constituents, including the five constituents of the Free Lunch portfolios that require active trading, have been removed from the Simplified Free Lunch portfolios in order to, well, simplify them. The allocation made to these constituents has been reallocated across trading strategies that provide the most portfolio diversification value. A listing of each constituent and the percentage allocated to it in the Simplified Free Lunch portfolios is provided in Figure 33. Similar to the composition of the Free Lunch portfolios displayed in Figure 29, this table also includes a listing of the actual investments you can make to replicate the performance of the Free Lunch Portfolios, as well as, if applicable, the number for the myth in which the trading strategy underlying the investment was introduced. Exposure to the 36% allocated to the global trading can be achieved with equal 9% investments in each of four managed futures mutual funds. These are the MFTOX, MHFCX, TFSHX and GPFCX funds.
88
Exposure to Each Return Driver/Constituent of the Simplified Free Lunch Portfolio

Constituent Cash Developed World Emerging Markets Aggregate U.S. Bonds Real Estate - U.S. Equal-Weighted Large Cap Frontier Markets Long International Bonds Long-Short Market Neutral Currencies - Carry Trade Currency - Momentum Currency - Fundamentals Currency - Cross-rates Int Rates - Momentum Int Rates - Fundamentals Int Rates - Yield Curves Stock Ind - Momentum Stock Ind - Fundamentals Stock Ind - Relative Value Energy - Momentum Energy - Fundamentals Energy - Relative Value Metals - Momentum Metals - Fundamentals Metals - Relative Value Ags - Momentum Ags - Fundamentals Ags - Relative Value Allocation 0.00% 5.00% 6.00% 7.00% 12.00% 5.00% 6.00% 7.00% 6.00% 6.00% 4.00% 3.38% 1.01% 2.36% 3.09% 1.86% 1.24% 3.09% 2.06% 1.03% 1.97% 1.18% 0.79% 2.25% 1.35% 0.90% 4.22% 2.53% 1.69% Investment CWI VWO AGG VNQ RSP FRN BWX TMNFX JMNAX.lw DBV Myth
Also incl in Conv port
4 16 10 10 11 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12 12
Global Trading Allocations can be made to managed futures accounts, private funds or mutual funds, as previously described.
Figure 33
Action Myth #20 89
The Leveraged Simplified Free Lunch Portfolios

To create the Simplified Free Lunch MR and the Simplified Free Lunch AR portfolios, all allocations would remain the same to each of the other portfolio constituents, with the exception of adding notional funding to the managed futures accounts that execute the global trading strategies. This is identical to how the additional performance is obtained in the regular Free Lunch portfolios. Figure 34 shows the increased allocation from the portfolio to the global trading managed futures accounts, that is required for each of the two Leveraged Simplified Free Lunch portfolios.
Allocations Required to be made to Global Trading in Each of the Three Simplified Free Lunch Portfolios
Portfolio Simplified Free Lunch Simplified Free Lunch MR Simplified Free Lunch AR Allocation to Global Trading 36% 48% 66% Increase 0% 12% 30%
Figure 34
The investor would still maintain the same 64% allocation to all other portfolio constituents. The process necessary to obtain the additional managed futures exposure is the same as that described for the Leveraged Free Lunch portfolios. The table on the following page summarizes the allocations to be made to each portfolio constituent for each of the six Free Lunch portfolios.
90
Summary of the Allocations to be Made to Each Constituent of Each Portfolio

Constituent Cash Large Cap - Static Long Mid Cap - Static Long Small Cap - Static Long Developed World Emerging Markets Aggregate U.S. Bonds High Yield Real Estate - U.S. Equal-Weighted Large Cap Ind Corp Fundamentals Dividend Increases Insider Sentiment Selective Small-cap Stocks Selective Growth Stocks Large Cap Liquidity Small Cap Liquidity Sector Timing Market Timing - International Frontier Markets Long International Bonds Long-Short Market Neutral Market Timing - Inv Sent Credit & Equity Arbitrage Currencies - Carry Trade Global Trading / Managed Futures (1) Myth Investment
Also included in Conventional portfolio
4 4 4 4 1 6 15 15 8 16 16 10 10 3 14 11 12 12 12 12
SPY MDY IJR CWI VWO AGG JNK VNQ RSP PRF VIG NFO Piotroski Strategy CAN SLIM Strategy AZLPX AZSPX Trade Funds Int'l ETF Strategy FRN BWX TMNFX JMNAX.lw Trade SPY & SH DBV MFTOX MHFCX TFSHX GPFCX
Free Lunch 0.00% 1.00% 1.00% 1.00% 1.00% 3.00% 4.00% 4.00% 10.00% 1.00% 1.00% 1.00% 1.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 3.00% 4.00% 5.00% 5.00% 7.00% 0.00% 3.00% 8.00% 8.00% 8.00% 8.00%
Free Free Lunch MR Lunch AR 0.00% 0.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 3.00% 3.00% 4.00% 4.00% 4.00% 4.00% 10.00% 10.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 1.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 3.00% 3.00% 4.00% 4.00% 5.00% 5.00% 5.00% 5.00% 7.00% 7.00% 0.00% 0.00% 3.00% 3.00% (1) Cash (1) Cash Level: 32% Level: 32% Trading Trading Level: 48% Level: 66%
Simplified Free Lunch 0.00% 0.00% 0.00% 0.00% 5.00% 6.00% 7.00% 0.00% 12.00% 5.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 6.00% 7.00% 6.00% 6.00% 0.00% 0.00% 4.00% 9.00% 9.00% 9.00% 9.00%
Simplified Free Lunch MR 0.00% 0.00% 0.00% 0.00% 5.00% 6.00% 7.00% 0.00% 12.00% 5.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 6.00% 7.00% 6.00% 6.00% 0.00% 0.00% 4.00% (1) Cash Level: 36% Trading Level: 48%
Simplified Free Lunch AR 0.00% 0.00% 0.00% 0.00% 5.00% 6.00% 7.00% 0.00% 12.00% 5.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 6.00% 7.00% 6.00% 6.00% 0.00% 0.00% 4.00% (1) Cash Level: 36% Trading Level: 66%
Figure 35.
Note to Global Trading / Managed Futures exposure in the MR and AR portfolios: (1) The additional exposure to global trading / managed futures is obtained by placing an amount of cash up to that available (the "Cash Level") in a leveraged managed futures account or fund that provides the exposure equal to the "Trading Level." Target returns on the Trading Level should be 10% - 12%.

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Action Section

Jackass Investing Action for Myth #1

Jackass Investing Action for Myth #1

Growth in $1,000 Allocated to Piotroski Trading Strategy On January 1, 2001

Figure 1. Source: AAII.com

Piotroski-based Trading Strategy Annual Returns

Figure 2. Source: AAII.com

Jackass Investing Action for Myth #1

Jackass Investing Action for Myth #1

Jackass Investing Action for Myth #3

Jackass Investing Action for Myth #3

Performance of the Sentiment Strategy Relative to SPY (Spiders)

Performance of the Sentiment Strategy Relative to SPY (Spiders)

Jackass Investing Action for Myth #3

Sentiment Strategy ETF Listing

Jackass Investing Action for Myth #4

Growth in Initial $1,000

$2,000 $1,500 $1,000 $500 $0

Jackass Investing Action for Myth #4

Jackass Investing Action for Myth #4

NFO S&P 500 TR

Growth in $1,000 Allocated to CAN SLIM Trading Strategy on January 1, 1998

Figure 10. Source: AAII.com

CAN SLIM Trading Strategy Annual Returns

Figure 11. Source AAII.com

Jackass Investing Action for Myth #6

Jackass Investing Action for Myth #7

Corn Wheat Soybeans Coffee Cocoa

Sugar Orange Juice Cotton Live Cattle Lean Hogs

Gold Silver Copper

Jackass Investing Action for Myth #7

S&P 500 TR 20 8.93% 14.98% -51% 63% 78% 80%

Trend Following 20 9.11% 7.81% -12% 65% 86% 84%

6,000 5,000 4,000 3,000 2,000 1,000 90 92 94 96 98 00 02 04 06 08 ec D D ec ec ec ec ec ec ec ec ec ec 10

S&P 500 TR Poor-folio Month-end Trend Strategy

Jackass Investing Action for Myth #8

These 20 Rydex mutual funds are:

Action Myth #10

Jackass Investing Action for Myth #10

Action Myth #10 55

Growth in Initial $1,000

$1,400 $1,200 $1,000 $800 $600 $400 $200 $0

Jackass Investing Action for Myth #10

Growth in Initial $1,000

$1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0

Action Myth #11

Jackass Investing Action for Myth #11

Performance of the PowerShares DB G10 Currency Harvest ETF (DBV)

4,000 3,000 2,000 1,000 93 95 97 99 01 03 05 07 ec D D ec ec ec ec ec ec ec ec 09

Action Myth #12

Jackass Investing Action for Myth #12

Action Myth #14

Jackass Investing Action for Myth #14

Action Myth #15

Jackass Investing Action for Myth #15

Back-tested Performance of the Liquidity Strategy Used in AZLPX and AZXPX

Action Myth #15 69

Growth in Initial $1,000

Growth in Initial $1,000

Action Myth #16

Action Myth #16 71

MSCI All -World ex-USA

Jackass Investing Action for Myth #16