White Paper December 2019

_____________________________________________________________________________

A tactical asset allocation solution to enhance a balanced

retirement portfolio

A suite of rules-based models driven by our proprietary market reward-to-risk oscillator

We have developed a proprietary method to extract how market participants as a whole are viewing the market

reward-to-risk tradeoff.

This oscillator exhibits a positive and sequential relationship with subsequent 1-3 month equity index returns.

Testing this oscillator in tactical allocation strategies over 20 years delivered superior return and risk metrics

versus respective benchmarks.

We create a range of model portfolios based on this oscillator and show the performance of each, the risks, and

how they fit into a portfolio.

Page | 2

Table of Contents

Introduction ………………………………………………………………………………………………………………………………… Page 3

Why it is unique ………………………………………………………………………………………………………………………….. Page 3

The oscillator …………………………………………………………………………………………………………………………….…. Page 4

Its relationship to future returns and volatility of returns ……………………………………….………….……….. Page 5

Using the oscillator in an investment strategy …………………………………………………………………………….. Page 6

How it fits into your portfolio ……………………………………………………………………………………………………... Page 7

Performance back-tests .……………………………………………………………………………………….…………………….. Page8

A. Total portfolio 60/40 solutions ……..…………………………………………………..…………….…………………….. Page 8

B. Carve-out sleeves ……………………………………………………………………………………………..…………………….. Page 10

Risks ……………………………………………………………………………………………………………………..…………………….. Page 12

How it differ from most other tactical timing models ……………………………………………..………………….. Page 12

Deciding on whether to utilize our models in your portfolio ………………………………..…………………….. Page 12

Page | 3

Introduction

This paper explains a tactical process of allocating assets between equity and bonds based upon a proprietary method

we have developed to assess the equity market reward-to-risk ratio.

This proprietary method is the culmination of ten years of research into modeling and understanding how the market

behaves. The basic concept is that the market generally tells you what it is thinking with respect to the reward-to-risk

trade-off, if you know where to look, and we have distilled that into a single oscillator which has been reasonably

predictive of equity index returns in the 1-3 month horizon. It is thus useful in tactical allocation.

At current equity market valuations and low interest rate levels, returns for retirement investors in a traditional

balanced 60/40 allocation are likely to be significantly lower than the typical 7.5% return that most pension funds are

assuming -based on measures that best correlate with long-term returns. Adding an active or tactical component to your

portfolio is really the only way to achieve higher returns.

We offer five model portfolios that may be suitable for investors currently employing primarily a passive balanced

60/40-type solution in their retirement portfolio and desire to add a tactical component with the goal of improving their

returns.

DISCLAIMER

We want to be very clear that this is a newly developed product and it has no live track record. The model results shown

in this paper, while impressive, are all based on testing on historical data. In addition, the model is proprietary and thus

it is a “black box” from your perspective. Please review the section in this paper detailing the “Risks” and consider

whether it is suitable for your particular circumstances. We offer this solution with the intention of helping you achieve

a better outcome with your retirement portfolio but, as with any investment offering, past performance is no guarantee

of future results. If you determine it is suitable for your portfolio, we recommend taking a prudent approach of starting

out conservatively with a small allocation, and adding to it over time provided it is working.

Why it is unique

The model is based purely on analyzing market internals, i.e. price action within multiple sectors in the market. The

output of the model is a single oscillator which represents our interpretation of the reward-to-risk ratio inherent in the

market. The model does not require any valuation or macroeconomic variables as inputs (valuations and economic data

are not predictive of returns in the near term, i.e. less than 5 years at best) nor does it employ trend following,

momentum or any type of pattern recognition strategy. The model has very few variable inputs and the results are

robust to changes in the variables. We believe this proprietary process is an innovative approach to using price action to

derive an investment fundamental, i.e. the reward-to-risk ratio.

Page | 4

The oscillator

Understanding the oscillator is simple. The blue zone in the middle is the neutral zone. Above the neutral zone is a

favorable reward-to-risk environment for equities and below the neutral zone is an unfavorable reward-to-risk ratio for

equities. There has been a strong and sequential relationship between the strength of the oscillator and 1-to-3 month

forward returns to the market; a favorable reward-to-risk ratio is associated with positive returns and an unfavorable

reward-to-risk ratio is associated with negative returns.

Page | 5

Its relationship to future returns and volatility of returns

In general, the higher above the blue zone, the better the returns, and the lower below, the worse the returns. In these

next tables we divide the oscillator’s range into 10 segments and analyze the 1-month and 3-month forward returns

depending on the position of the oscillator. We evaluated data for 21 years (2/4/99 to 9/19/2019) or 5,177 days going

back to 1999.

Table 1

Key observations:

a) There is a positive sequential relationship between the strength of the oscillator and the size of future equity returns

(Column 2).

b) There is an inverse relationship between the strength of the oscillator and the volatility of future equity returns

(Column 3).

c) There is generally a positive sequential relationship between the strength of the oscillator and the percentage of

winning trades. Column 6 shows the percentage of 1-month and 3-month returns that are greater than zero for each day

that the oscillator is in each state. For example in State 9 (Column 1) on the 1-month table, the oscillator was in this

state for a total of 235 days, and of those days, 167 or 71.06% of the time, the equity index was higher one month later.

d) We also show the returns to intermediate term bonds (VFITX) which are generally opposite those of equities (Column

8). In other words when equities are doing well, bonds are doing poorly.

e) For reference purposes only, Column 7 shows the average value of the volatility index, VIX, during each state. Notably,

our oscillator state does not exhibit a uniformly sequential relationship with VIX.

1 2 3 4 5 6 7 8 9

1-month forward returns

Row Labels Average of SPY-20 StdDev of SPY-20_2Count of SPY-20_3Sum of SPY-20+1Average of SPY-20+1_2Average of Vix Average of VFITX-20 StdDev of VFITX-20

10 0.94% 4.04% 260 169 65.00% 23.48 -0.77% 1.33%

9 1.51% 3.74% 235 167 71.06% 19.57 0.37% 1.04%

8 1.20% 3.34% 669 456 68.16% 18.47 -0.35% 1.30%

7 1.43% 3.65% 983 704 71.62% 18.58 0.06% 1.19%

6 0.00% 3.95% 791 483 61.06% 17.13 0.28% 1.22%

5 0.98% 3.71% 457 309 67.61% 17.64 0.01% 1.26%

4 -0.97% 4.70% 605 257 42.48% 18.59 0.14% 1.25%

3 -0.25% 5.46% 700 393 56.14% 19.97 -0.11% 1.34%

2 -0.53% 6.47% 271 159 58.67% 24.23 0.12% 1.33%

1 -3.24% 6.29% 206 76 36.89% 36.18 0.71% 2.23%

Grand Total 0.32% 4.54% 5177 3173 61.29% 19.74 0.02% 1.34%

3-month forward returns

Row Labels Average of SPY-50 StdDev of SPY-50_2Count of SPY-50_3Sum of SPY-50+1Average of SPY-50+1_2Average of Vix Average of VFITX-50 StdDev of VFITX-50_2

10 2.72% 5.04% 260 179 68.85% 23.48 -1.02% 1.27%

9 3.29% 3.00% 235 200 85.11% 19.57 -0.15% 1.89%

8 2.38% 5.20% 669 493 73.69% 18.47 -0.50% 1.83%

7 2.04% 6.22% 983 691 70.30% 18.58 -0.11% 2.14%

6 0.48% 6.32% 791 477 60.30% 17.13 0.57% 2.07%

5 2.07% 5.93% 457 311 68.05% 17.64 0.24% 1.73%

4 -0.98% 5.81% 605 294 48.60% 18.59 0.56% 1.81%

3 -0.14% 7.78% 700 419 59.86% 19.97 0.03% 2.42%

2 -2.03% 12.65% 271 172 63.47% 24.23 0.20% 2.18%

1 -4.71% 7.44% 206 61 29.61% 36.18 0.17% 2.60%

Grand Total 0.81% 6.91% 5177 3297 63.69% 19.74 0.05% 2.08%

Page | 6

In sum, the strength of our oscillator does a reasonable job of differentiating stronger from weaker returns going

forward 1-3 months and is thus we think useful in assisting tactical allocation decisions. This is the core feature of our

intellectual property.

Using the oscillator in an investment strategy

Once you have an indicator that can provide an edge with respect to timing the equity market, pretty much any asset

allocation strategy that it is applied to will deliver good results. From here on out it just about how we design the rules

for each model strategy.

We have designed a variety of model portfolios for investors who are generally in a 60/40 type passive balanced

allocation and wish to add a tactical tilt to try and enhance their performance. Some of the models are total portfolio

solutions and some are intended as a carve-out sleeve of your core portfolio.

All our model strategies run off of this same signal from our oscillator - the only real difference between each of the

models is the level of tilt that we apply based on the strength of the oscillator; some models have a conservative tilt and

some have a more aggressive tilt.

We have segmented the oscillator range into five segments; a neutral zone in the middle and two zones above and two

zones below. For each model we then predetermine the allocations for each zone. It is a rules-based process with no

emotion or human involvement. Here are the five models with the zones and equity allocations for each. Whatever part

of the portfolio is not invested in equity is placed in intermediate term government bonds. We utilize only two ETFs for

all our models; SPY and IEF. You can obviously choose differently if you desire.

Table 2

Strategies based on the position of the oscillator perform significantly better than their benchmarks on all metrics

when tested on historical data going back 20 years. A distinguishing characteristic of the strategies is that they

significantly outperform in years when the market is down, while still at least matching or outperforming the

benchmark in years when the market is up.

Model equity allocation schedule

Oscillator zone Model 1 Model 2 Model 3 Model 4 Model 5

Very favorable 90% 80% 70% 100% 125%

Favorable 75% 70% 65% 100% 100%

Neutral 60% 60% 60% 50% 50%

Unfavorable 40% 45% 50% 0% 0%

Very unfavorable 20% 30% 40% 0% -25%

Page | 7

How it fits into your portfolio

We provide you with a variety of ways, or model portfolios, to implement our model; some of them are a carve-out

sleeve of your core portfolio, and some of them are total portfolio solutions. Lastly if you are doing shorter-to-

intermediate term trading, you can use our oscillator to guide your trading direction, since it’s best to be in harmony

with the larger direction of the market.

Total portfolio solutions; typically a provider will offer a target date fund or a range of model portfolios representing

various risk tolerances with the assumption that you are putting your entire portfolio into their product. For this

category we offer three models which use the 60/40 as a benchmark; aggressive, moderate, conservative. These models

are suitable for someone who is currently or plans to invest in a balanced 60/40 fund or allocation, but now wants to use

our model to take a more tactical approach to the balanced allocation; in other words, tilt the equity exposure up above

60% when the reward-to-risk ratio is positive and reduce it below 60% when it’s negative. The size of the tilt will

determine which risk level model you choose.

Carve out sleeves; we put forward two models, one is a conservative sleeve which uses a 50/50 as a benchmark, and the

other is an aggressive sleeve which uses the only the equity index as the benchmark. These are good if you are a long

term self-directed investor - trying to add some alpha to your core balanced portfolio. If our allocation is 100% in

equities then your total portfolio equity exposure would tilt up. If our allocation is 100% in government bonds then your

total portfolio equity exposure would tilt down. These models are designed to be a carve-out of your existing balanced

allocation. In other words, we recommend that your keep your existing balanced portfolio for the most part, but take

some percentage of it to allocate to our solution. The amount you re-allocate from your balanced allocation to our

solution would depend upon your risk tolerance.

Page | 8

Performance back tests

The following shows what the performance for each of the five models would have been based on applying the pre-

determined equity allocations (from allocation Table 2 above) for each models based upon the position of the oscillator.

For all models, the percentage not invested in equities is invested in intermediate term government bonds. For the

equity allocation we utilize the SPY (S&P 500) and for the bond allocation we use VFITX (Vanguard Intermediate Term

Bond Fund). We assume daily rebalancing in back testing.

A. Total portfolio 60/40 solutions – benchmark is 60% SPY/40% VFITX

Model 1 – 60/40 with aggressive tilt

The smaller inset table shows the equity allocation level (Column 1) along with the total returns and time spent in each

level.

Page | 9

These tables show Model 1 again, alongside Models 2 and 3, which are more conservatively tilted.

How to interpret these results?

Using the moderate tilt as an example (see highlighted items), the average annual outperformance was 2.52% per year

versus the benchmark. The model outperformed the benchmark in 76% of all years. In years when the market was

down, the benchmark was down an average of 7% and our model was flat at 0%. In years when the market was up, the

benchmark was up an average of 10% and our model was up an average of 11%. The Sharpe ratio of 1.18 is 1.79 times

better than the benchmark 0.66. The information ratio is 0.68.

In all five models, a significant part of the outperformance is obtained by avoiding the downturns better than the

benchmark.

Page | 10

B. Carve-out sleeves

Model 4 - Conservative 50/50 baseline

Benchmark is 50% SPY/50% VFITX

Page | 11

Model 5 -Aggressive leveraged long-short equity

Benchmark is 100% SPY

[INVESTING TIP - A precautionary note on equity curves: As a general rule when evaluating any strategy, be very careful about coming to a

conclusion based on an equity curve graph such as this. It can be very deceiving, depending on the start and end date. We always recommend

looking at the year-by-year returns as we show above.]

Page | 12

Risks

Model risk; this is a proprietary black box algorithm and you have no way of knowing how or whether it actually will

work. Unfortunately, that is the nature of proprietary models. Any prudent advisor will tell you that this is a valid risk

and that you should start small and see how it goes. We agree.

Oscillator predictive ability; while our oscillator has done a good job of distinguishing between periods of good versus

weak returns, there is no guarantee that it will continue to exhibit this relationship:

a) Unanticipated downturn; the biggest risk in implementation is that the market experiences a downturn which our

model does not anticipate. In this case, you would be holding an overweight position in equities and would experience a

larger loss than your baseline portfolio. With this in mind, for whichever model you select, be sure to consider what

your maximum portfolio allocation to equities could be and make sure you won’t exceed that.

For example, if 80% of your portfolio was in a 60/40 fund and 20% was in our model, there will be times when your total

equity allocation would be 68%. (60% x 80% = 48%) + (100% x 20% = 20%) = 68%.

b) Missing out on equity rally; the opposite of that could also happen where the model has taken a cautionary stance

and yet the equity market rallies. In this case you likely won’t lose money because you will still be invested in

government bonds, but you will lose out in the sense that you won’t participate in the markets gains.

How it differ from most other tactical timing models

Being totally-in or totally-out of ("risk-on" or “risk-off") the equity market as most timing models prescribe does not

work in our opinion. Logically, it does not make sense that one day you are 100% in equities and the next day you are 0%

in equities; it is not possible to time the market that precisely, so that is not a sensible strategy.

Our oscillator actually has a sequential relationship between the strength of the oscillator and the size of future returns

– stronger oscillator equals higher returns and weaker oscillator equals weaker returns. We thus tilt the equity allocation

in the direction of the oscillator. This allows an investor to scale in or out of an asset class gradually, which we believe is

more sensible than the binary in-or-out models.

Deciding on whether to utilize our models in your portfolio

We believe we have built a good framework for navigating the market but acknowledge that it is a new product with

certain risks, some of which we outlined in this paper. The decision to utilize any of these models is however entirely

dependent on your own individual circumstances, investment horizon, retirement preparedness and ability to take on

risk. Starting out small and cautious is prudent.

________________________________________________