PivotPoint’s Signature Investment Model

The goal is to beat the stock market.

The Vision

Even though it’s very, very easy to match the market by buying and holding an S&P 500 Exchange-traded fund (ETF) like SPY, most retail investors and large fund managers underperform the market. Fund managers try to earn your money by beating the market. They work under limitations that make it more difficult. They often can’t take meaningful holdings in smaller stocks because of complications in holding more than 10% of a company’s stock or allocating more than 5% of their funds’ capital in any one stock.

Those limitations don’t come into effect for PivotPoint Advisors. At least not yet. On January 1st, 2021 we launched the PivotPoint Signature model portfolio to beat the market for the firm’s funds and clients who subscribe. Our track record is short as of this writing, but we’re off to a proper start. We are meticulously measuring the performance—returns, volatility, and correlation with the overall market. This is an aggressive fund by definition; the goal is to beat the market. This model may not be appropriate for the conservative investor who can’t easily tolerate the downs. It may not be appropriate for the bulk of a retiree’s investment portfolio… but it may be perfect for the retiree’s allocation for growth. As long as a person is invested in stocks, some portion should be allocated to growth to at least offset inflation.

The model portfolio consists of five blended parts. The relative proportion is adjusted from time to time to adapt to constantly changing market conditions:

  1. Core Asset Allocation
  2. Small and mid capitalization value stocks
  3. Momentum stocks or market hedging
  4. Cryptocurrency
  5. Cash

We expect this to be a fairly low turnover portfolio. The main action will be in the Value Stocks portfolio where there may be a changeover of between 10-20 stocks per year. Rebalancing will require a number of transactions. Our custodian, Charles Schwab & Co, Inc., offers $0 commission on stock and ETF trades. All our trades are stocks and ETFs.

Asset Allocation

Most of the performance of any portfolio can be predicted by the types of assets it contains. Stocks and bonds are the broad classifications. Stocks are broken down into large, medium, and small capitalization. Those headquartered in the United States vs other countries. Those that offer a dividend. The classes can get as detailed as any investor likes. Bonds are broken down into government and corporate, short or long term, and by credit risk. There are low expense ETFs that allow an investor to easily put any percentage of their portfolio into any class of asset. Asset allocation is the core part of a portfolio for all but the most conservative or most aggressive. It allows everyone to find their comfort zone in setting and meeting their financial goals.

PivotPoint uses a select group of ETFs for the following asset classes:

  • Large cap growth stocks
  • Large cap value stocks (dividend payers)
  • Medium capitalization stocks
  • Stocks in international developed economies
  • Stocks in international emerging economies
  • Short term US Treasuries
  • Long term US Treasuries
  • Investment grade corporate bonds

We don’t use any ETF for small cap stocks in PivotPoint Signature. It would be redundant to the holdings in the Value Stocks portion of the portfolio.

This is the safety-first portion of PivotPoint Signature and will always be the bulk of it. This portion will generally be in line with overall market performance. It will maintain much lower costs than mutual funds, which means it’ll outperform 80% of them. Therefore, PivotPoint Signature will probably never massively outrun the market. We aim to win by a few percentage points every year, maybe more. Safety first requires that.

Value Stocks

It’s difficult to beat the market with buy-and-hold asset allocation ETFs only. The massive diversification within them ensures your portfolio keeps up with the market. To pull ahead of the S&P, you’ve got to pick stocks, a hot sector, or do something fancier and riskier with derivatives. When we at PivotPoint speak of beating the market, we mean on a risk-adjusted basis. You can make wild bets, get lucky, and destroy the market. For one year. Maybe a few years. But eventually your wild bet is going to lose in spectacular fashion. That’s not our way.

There are well-studied methods for picking stocks that will beat the market. These stocks often can’t be used by big institutional funds. They need a lot of shares to move the needle in a big fund, and that big a position will tilt the market too much for a security with relatively low volume. That gives the retail investor, like us, some opportunities to find bargains that the heavyweights have to ignore. We employ a two step process to create the Value Stocks portfolio:

Step 1: Select a group of stocks with great potential to beat the market. There’s more than one approach to do this, but our approach is to maintain tight focus on small cap value stocks. The market is herd driven: while money follows crowd favorites like Tesla or Shopify, some money is leaving good stocks that earn profits. Most often these are small stocks that have less than zero buzz. The hypothesis (and history bears out) is that eventually the market gets smarter about that stock and money flows into those stocks. Our goal is to get those stocks in our portfolio just as the market is discovering (or rediscovering them). A common finding is this approach can result in 17% annual returns. The overall market has a historic average of 10%. An extra 7% over years makes a BIG difference in your account balance.

Step 2: Select a subset of promising stocks and blend into an efficient portfolio. Step 1 might be 95% science and 5% art. Step 2 is at least 25% art. We are aware of the overall business cycle and which market sectors should outperform. We avoid too much concentration in one sector or industry. At times this is difficult…the best opportunities often cluster. Right now (early 2021), for example, health care companies hold a lot of the market-beating potential. Then we need to analyze the correlations among the stocks and to the market overall. We want a variety of stocks that don’t all move in the same direction at the same time. By doing this correctly, a portfolio of only 15 or so stocks can be diversified enough to be the main portfolio for an aggressive investor.

Step 1 is selecting the prime, fresh, organic ingredients; step 2 is combining and cooking them into a delicious soup.

Momentum & Hedging

Stocks get hot. Sectors get hot. Irrational manias can develop for any number of reasons and we don’t want to turn up our noses to the profits that can be made. These positions will always be small and considered a speculation, not an investment. That mindset makes all the difference in how they’re treated. PivotPoint Signature didn’t participate in the recent GameStop madness, but this is an example of where we might make a small (1-2% of portfolio), short-term bet to grab some of the action when conditions look favorable.

We expect a significant market crash in 2021 or 2022 at the latest. We will keep a close eye and get out of the way by going at least partially to cash. At the right time, we’ll probably take a short position against the market in a bear ETF that profits as the market declines. Avoiding some of the damage of foreseeable market crashes is part of the long-term value of PivotPoint Signature.

Cryptocurrencies

Crytpo isn’t leaving. We can’t say we understand exactly where it’s headed, but the overall idea has crossed a threshold and is moving into the mainstream economy. Also, crypto growth is uncorrelated with stocks. That’s a great attribute for diversification and risk control over a portfolio. It’s volatile; a portfolio like ours manages that by limiting the amount of the bet.

Cash

It’s useful to keep a small portion of a portfolio in cash (money markets) to allow for flexibility and a cushion of safety. A bit of cash is a lubricant that helps the portfolio running smoothly.

Recent Portfolio Highlights

Core Asset Allocation

The current unusual market conditions have made bonds very unattractive for any growth purpose. This will change as inflation sets in a bit and US stimulus money winds down. On a risk adjusted basis, US large cap companies dominate the field of asset classes. Right now, PivotPoint Signature only holds large cap growth and large cap value ETF positions.

The model will adapt with the situation; we won’t stick to a rigid playbook.

Value Stocks

AmerisourceBergen Corporation (ABC, Website): They are a pharmaceuticals logistic company. The make sure the drugs other companies make show up when and where they’re needed. Like some other PivotPoint value stocks, they are strongly recovering from bad news. AmerisourceBergen recently took a significant hit–along with a few other similar companies–to settle an opioid lawsuit. The company otherwise is remarkably effective. Employees love it and respect the CEO (something we look for). This company is a bit larger in market cap than any other in the portfolio. We’ll stray slightly from our guidelines at times, and this investment is an example.

SIGA Technologies (SIGA, Website): This company is in the health security market, leading the way with treatments for small pox in the case of a bio attack. The company signed a big contract with the United States and the value of that cash inflow is not nearly reflected in share price. Yet. The market is busy bidding up Apple to unseen heights. Here is a nearly ideal example of a small cap value stock profile and hopefully how investment capital eventually finds it.

OneMain Financial (OMF, Website): Not as large as ABC, but OMF is also outside the technical range of “small cap”. This company offers a variety of consumer financing products. OneMain has a very stable earnings history—aside from the COVID quarter—and is now becoming a bit more widely known to investors, and volume picked up in January.

Cryptocurrencies

We have taken a small 1.5% position in the portfolio in cryptocurrencies. The current vehicle is a liquid, tradeable trust that hold Bitcoins. This seems to be a prudently small exposure to this very volatile market. We believe cryptocurrency is here to stay, so it’s a must to invest in its growth.

Momentum Stocks & Hedging

None at this time

Performance Update – February 2021

We’ll track performance of the portfolio using 3 metrics:

  1. Annualized portfolio return vs. the S&P 500. We’ll use the SPY ETF as proxy for the market. We annualize to give perspective on how the portfolio and the market are performing against the 10% historical return of the total stock market.
  2. Volatility vs the S&P 500 – this is a measure of how unpredictable the returns are. We use equally weighted moving average (EWMA) volatility which gives recent changes more weight. We hope the value stocks portion of the portfolio provides protection against downside volatility—these stocks shouldn’t lose much value for long. They’re already a bit beaten down.
  3. Correlation with the market. SPY by definition is 1.0 since it IS the market for our purposes. PivotPoint Signature model seeks some amount “pure alpha” which means gains that are relative uncorrelated with the market. If successful, this provides additional diversification. We’d like to see the correlation as low as possible, less than 70% whenever possible. The portfolio is dominated by core ETFs, so the correlation will always be fairly strong. It’s the price we pay for a safety margin.

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