Ascendere Monthly Update — Sep 30, 2010 -- Rebalance All Long/Short Model Portfolios

8/8/2019 Ascendere Monthly Update — Sep 30, 2010 -- Rebalance All Long/Short Model Portfolios

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Ascendere Associates LLC September 30, 2010J. Stephen Castellano Page 1 [email protected]

Ascendere Associates LLC www.ascenderellc.com

J. Stephen Castellano [email protected]

Model Portfolio Monthly Update: September 30, 2010This report updates our model portfolio strategies as of the close, September 30, 2010.

New Actions Required:

Rebalance the stocks in the model portfolios to equal weight positions.

Rebalance long and short portfolios to equal dollar amounts.

See pages 5-6 for details.

Table of Contents:

Page 2: How to Use this Newsletter

Page 3: Return Data

Page 4: Overview, and Target and Stop Loss Returns for Model Portfolios

Pages 5-6: Rebalancing Actions

Pages 7-8: Target and Stop Loss Prices for Stocks

Pages 9-11: Frequently Asked Questions

Page 12: Potential Transaction and Slippage Costs Relative to the Model

Pages 13-15: Methodology, Disclosures, Disclaimers

Page 16: About Ascendere Associates LLC

http://www.ascenderellc.com/


mailto:[email protected]








How to Use this Newsletter

Uncover Great Stock IdeasIn our opinion, cash flow growth and return on invested capital are the key drivers of any stock's valuation. By focusing on various proxies for these

data points and other factors such as fundamental quality, analyst revision momentum and relative value, we have been able to generate some

terrific investment ideas and avoid some significant value traps. Generally speaking, we try to find the best stocks that demonstrate solid growth ata reasonable price (GARP). There are two ways investors can use this newsletter:

Long-term Idea Generation

One way that investors use this newsletter is to generate a solid list of potential stock ideas to conduct further fundamental analysis. On numerous

occasions, new stock ideas have appeared on major sell side conviction buy and sell lists days or even weeks after they appeared on our list, as

detailed in our "Nostradamus" report. We have used ideas on this list to flush out our own detailed long-term analysis of stocks, as we have

demonstrated with our reports on McKesson (MCK), Starbucks (SBUX) and others. Based on our backtests going back to 12/31/2004, buying and

holding stocks from our Core Model Long portfolio at the end of any given month would have returned on average more than 10%, ranging from as

low as -53% for the period 11/30/2007-11/30/2008 to as high as 61% for the 02/28/2009-02/28/2010 period.

Build Your Own Hedge Fund

Another way to use this newsletter is to build a dollar-neutral model portfolio that mimics our Core Model or Opportunistic Model. These model

portfolios are derived from the Naive Model and are typically rebalanced monthly. The Core Model, which begins each month in a dollar-neutral

position, demonstrated a cumulative return of 220% with a Sharpe Ratio of 1.54 since its backtested 12/31/2004 "inception". Both the Core and

Opportunistic Models use the same set of stocks and stock-specific target prices and stock-specific stop loss prices, but the Opportunistic Model

also incorporates portfolio-specific target prices and stop loss targets. As a result, the Opportunistic Model is not always dollar neutral, and these

"opportunistic" portfolio allocations have resulted in a lower cumulative return but higher Sharpe Ratio over the backtest. These backtests are no

guarantee of future results and do not assume any kind of costs. At a minimum, we think that tracking the returns and decision making in thismodel portfolio would be useful to follow as an alternative benchmark index.

Ascendere Associates currently manages a long-only account based largely in part by the Opportunistic Long Model Portfolio. Please see the back

of this report, which includes answers to frequently asked questions, and provides information on our methodology, disclosures and disclaimers.

http://www.scribd.com/doc/28490029/Goldman-Sachs-Nostradamus-and-Genetic-Algorithms-versus-Simple-Quantitative-Models-Experience-and-Common-Sense



http://www.scribd.com/doc/28381795/McKesson-Corporation-One-of-the-Best-Healthcare-Stocks-to-Own



http://www.scribd.com/doc/28382058/Starbucks-Improving-Across-the-Board-Is-That-Enough









* This table represents a theoretical model, and is presented for informational purposes only. The figures above are gross returns of various models and do not assume any

kind of cost. This table is not to be construed as any advertisement of any investment service.

The "Naive" Model is so named because it excludes risk management and other refinements and is intended to show the returns due to fundamental factors alone, which

include operating momentum, relative value, fundamental quality and analyst revision momentum. Typically the Naive Model comprises approximately 80-100 stocks.

The Core Model is a refined version of the Naive Model and uses stock-specific price targets and stops. Over the backtest, the number of stocks in the Core Model has

comprised on average approximately 22 stocks in the long portfolio and 15 stocks in the short portfolio.

The Opportunistic Model uses the same stocks and stock-specific price targets and stops of the Core Model, but it additionally applies target and stop loss rules to the long and

short portfolios. This model is usually dollar neutral, but when target or stops are reached this model could change to 100% long or short or to 100% cash at any given time.

Return of Stocks in the Long Portfolio - Return of Stocks in the Short Portfolio = Return of Overall Portfolio. YTD returns are based in part on backtested returns. Returns of the

Naive Model have been tracked in real time since December 31, 2010. Returns of the Core has been tracked in real time since July 31, 2010. Returns of the Opportunistic Model

have been tracked in real time since August 31, 2010. Cumulative returns and the Sharpe Ratios are calculated from the 12/31/2004 "inception." The risk free rate used in the

calculation is the 90-day T-bill, which has averaged ~2.41% since 12/31/2004. None of these models assume any kind of expenses.




Core Model Portfolio and Opportunistic Model Portfolios

The Core and Opportunistic Model Portfolios are a subset of the Naive Model Portfolio.

Both the Core and Opportunistic Models use the same stocks and same rolling stock-specific targets and stop losses.

However, the Opportunistic Model also incorporates portfolio-based, static price targets and stops, as outlined below.

Portfolio Targets and Stops Available to Paid Subscribers

The backtested returns of these model portfolios do not assume any kind of costs, and additionally assume that investors are

able to purchase the stocks at the previous day's closing price. Of course this is not always possible. Based on a preliminary

backtest to 12/31/2004, we have found that stocks in the long models appreciated on average ~0.40% on the first day of the

month and that stocks in the short models have declined on average ~0.10% on the first day of the month. This mayrepresent the average worst-case slippage costs.

We have not backtested returns of stocks from the previous-month's list that carry into the first day of the next month, but

these returns would probably have a mitigating impact on the above figures. Another factor in further mitigating potential

slippage costs is the fact that it is not always necessary to rebalance stock positions that were already on the previous month's

list.

Separately, both of these models utilize portfolio price momentum factors: On rare occasions, perhaps over several days over

any given year, these models will go long "low-quality" stocks and short "high-quality" stocks. However, the occurrence was

more frequent during the 2009 market rally, which was driven by returns of "low-quality" stocks.




Core and Opportunistic Long Model Rebalancing




Core and Opportunistic Short Model Rebalancing




Core and Opportunistic Long Model Portfolio, with Initial Targets

Opportunistic Long Model

Target Returns and Stop Losses for the month

Available to paid subscribers




Core and Opportunistic Short Model Portfolio, with Initial Targets and Stops

Opportunistic Short Model

Target Returns and Stop Losses for the month

Available to paid subscribers




FREQUENTLY ASKED QUESTIONS

What is a dollar neutral portfolio?

A dollar neutral model portfolio assumes an investor is long and short and equal dollar amount. For example, a $100,000 portfolio would be considered dollar

neutral if the long portfolio was set at $50,000 and the short portfolio at $50,000. Market neutral portfolios do not have any market exposure -- the average

betas of the long and short positions offset one another. Our models start each month in a dollar neutral position. As time goes on, these portfolios may

become weighted more or less to the long or short side, depending on the various price targets and stop losses reached.

Why would I want to invest in a dollar neutral portfolio instead of a long-only portfolio?

In theory, by initially being both long and short an equal dollar amount of stocks investors are trading the potential for absolute gains for better risk adjusted

gains.

Do the model returns reflect the potential for real returns?

No. The models in this newsletter have been created for informational purposes only. The return data we provide do not include any assumptions or estimates

for costs or fees. This newsletter should be considered a tool in helping sophisticated investors make their own trading decisions after thoroughly reviewing our

disclosures and disclaimers. We are providing models to guide your own judgment and help with your decision making; we are not providing a "how-to" manual

or tracking real trades.

Where are the stocks for the Naive Model Portfolio?

We decided to omit this model for clarity's sake. Subscribers interested in tracking this base model from which our other model portfolios are derived may do so

on request.

I am a new subscriber and I want to build my own hedge fund. How do I get started?

Once again, we must emphasize that we only recommend that experienced investors follow and implement our strategies, and only do so after thoroughly

reviewing our disclosures and disclaimers. We are providing models to guide your own judgment and help with your decision making; we are not providing a

"how-to" manual or tracking real trades.

We recommend obtaining an account that charge low fees for executing transactions. We currently use Interactive Brokers to execute our trades. Next, you canmimic our model portfolios in any way you want. Our backtests assume that stocks in any portfolio are equal-weighted and rebalanced at least monthly,

regardless of whether they are new stocks to the model or carried over from the previous month.

Do you recommend following the model portfolios exactly?

There are always exceptions to any rule. The savvy investor should use their experience and judgment to try to outperform these models. Perhaps the best

example of when to ignore the models could be seen with its past sales of Apple (AAPL) and Netflix (NFLX). These stocks moved off our screens due to relative

valuation factors while other factors stayed highly ranked. In other words, these stocks moved from GARP (growth at a reasonable price) territory to growth

territory. An experienced investor might recognize this and hold these stocks as opposed to selling them.




In addition, an investor may want to purchase a stock that has recently moved off a low-quality list due to drastically increased analyst revision momentum. For

the highly sophisticated investor, we provide a weekly update with ranking data as a separate subscription. We recommend using the model strategies as a

guide and not a "how-to manual."

Do you mange any accounts based on your model strategies?

Yes. Ascendere currently manages a long-only portfolio based largely in part on the model portfolios in this newsletter and partially based on discretion. We are

making plans to make this account available for auto-trading.

I rather have Ascendere Associates LLC manage an account based on a particular model portfolio strategy. How do I do this and what are the fees?

Ascendere Associates is a registered investment advisor in New York State, and is willing to obtain registration in other states if there is demand. Contact us

directly for more information. In addition, plans are being made to have a portfolio based largely upon the Opportunistic Long Model Portfolio account to be

available for auto trading.

Do you adjust your model portfolios for corporate action announcements, like M&A activity?

No. Our models are based on factors alone, and not on pending corporate actions such as mergers. We suggest readers use their own judgment as to whether

to include stocks that are potential acquisition targets.

It is not always possible to borrow stock to execute short sales. Do your models take this into account?

No. The models and backtests have assumed that the stocks have always been available for short selling. We would note that there was a period in 2008 the

SEC prohibited short selling of certain financial stocks, which our models also have not taken into account. If a stock is not available for short selling, a reader

may keep that portion in cash, rebalance the portfolio with fewer short-sellable stocks, or replace the missing stock with a 75% equivalent position in an inverse

ETF. We do not recommend replacing a missing short sale position with a 100% position in an inverse ETF based simply on our opinion that ETFs offer no edge

relative to our stock-specific models. As always, we urge readers to use their own judgment.

Why do you use the S&P 500 as a benchmark? Why do you exclude returns from dividends from the benchmark and model portfolio strategies?

We use the S&P 500 because it is widely accessible to all readers and provides a general idea of market direction relative to the direction of the model portfolio

strategies. We do not include returns from dividends in the S&P 500 because we also do not track returns from dividends in the model portfolio strategies. This

is because we track changes in price only for the models. Most importantly, the models are likely long and short roughly the same amount of dividends because

of the initial dollar neutral construction of the model portfolios each month.

A truly relevant benchmark for our model portfolio strategies would be based on all stocks and ADRs that trade on major U.S. exchanges with a market cap

above $2 billion. Hedge fund indices are also available, such as from BarclayHedge, Ltd., but these are updated monthly. The Barclay Equity Long/Short Index is

probably most relevant to our dollar neutral models.

http://www.barclayhedge.com/



http://www.barclayhedge.com/research/indices/ghs/Equity_Long_Short_Index.html








Where do you get your data?

We use data provided by Capital IQ, which is in our opinion one of the most innovative financial data companies in business.

How do you calculate your factors and factor models?

Our models are proprietary. For some general insight, see our "methodology" section below.

How you determine stock-specific targets and stops?

We take a ratio of a stock's volatility to determine monthly stock-specific price targets and stops, and use static and volatility-based percentage changes forportfolio targets and stops. If you wish to set your own stops and would like additional insight into our approach, we can provide some additional detail to paid

subscribers. Please contact us directly.

The Opportunistic Portfolio seems risky in that it could drastically exchange exposure from dollar neutral to 100% long, 100% short. Are there alternatives?

We have tried different variations of our models in backtests, and did not find any benefit to cumulative gains or the Sharpe Ratio by closing out an entire dollar

neutral portfolio or going to a market ETF if the long or short model was stopped out instead.

For example, if an investor were to close out of all stock positions and replaced them with a 75% equivalent position in a S&P 500 ETF instead of going to cash,

we found the cumulative return from 12/31/2004 was about 125% with a Sharpe Ratio of 1.37. If an investor were to close out of all stock positions following

the stop of any one portfolio, the cumulative returns would be close to 100% with a Sharpe Ratio of 1.27. Drawdowns would be lower, but the risk adjusted

returns would be worse than our existing Core Model Portfolio. Our Core Model Portfolio, unlike our Opportunistic Model Portfolio, is always dollar neutral. At

the time of this writing, this model has demonstrated a 220% cumulative return with a Sharpe Ratio of 1.54.

How often do you rebalance the model portfolios?

The model portfolios are typically rebalanced following the close of each month. However, there will be occasions when intra-month rebalancing is necessary --

sometimes we will go long "low-quality" stocks and short "high-quality" stocks based on price momentum factors. On other occasions, in the Opportunistic

Model, we may close out one or both portfolios completely.

Why don't you update and rebalance your model portfolios more frequently?

Based on a few short backtests and anecdotal observations, we learned that there is no advantage to rebalancing the model portfolios more frequently than

month to month. We think this may be because of highly sophisticated institutional quantitative programs that are shorter-term in nature. As thesequantitative funds chase intra-day price fluctuations and compete on information process speed, a slower-moving quantitative model such as ours may be

better able to pick up on general mispricing relative to key fundamental factors. The advantage of our systems seems to come from its ability to anticipate

future changes in stock direction as opposed to quickly reacting to new information.

Do your calculated model portfolio returns include expenses?

No. Please see the section below, "On costs associated with executing trades based on a model portfolio."




ON COSTS ASSOCIATED WITH EXECUTING TRADES BASED ON A MODEL PORTFOLIO

Our models assume that investors rebalance their long and short positions on a monthly basis, though of course the actual allocation strategies are up to the

individual investor. Keep in mind that IRA accounts are unable to use margin, and hence are unable to short sell stocks.

Before executing a dollar neutral portfolio, it may make sense to determine the associated costs. Below we provide a brief overview of what investors could

reasonably expect in terms of transaction and slippage costs.

Transaction Costs

Using the 08/31/2010 model as an example, there are 19 long stock positions and 19 short stock positions, or 38 stocks in total. This is close to the average of 37

stocks that we have seen over the course of our backtests.

A 38-stock portfolio may on a worst-case basis require 76 transactions to implement each month, assuming 38 positions are closed and 38 positions are opened.

Assuming $1/trade through Interactive Brokers, executing these trades could cost at least $76/month, or $912/year, if not a bit more. But since some stock

positions will not be rebalanced every month (since they could be carried over from the previous month), the actual transaction costs may be a bit lower than

this -- perhaps $62.50/month or $750/year.

Slippage Relative to the ModelNext, expectations for slippage costs should be taken into account. If the average closing price of stocks on the first day of the month relative to previous day's

close in our backtests are any indication, investors should assume they will lose 0.4% on average per month in implementing long-trades and 0.10% per month

executing short sale trades relative to the model. This could mean that on an annualized basis, real returns relative to the model could lag by at least 6%. But

slippage works both ways -- one will sell stocks at prices different from the model AND purchase stocks at prices different than the model, so price-based

slippage may be a bit lower than this.

There are additional costs associated with short selling, such as margin costs and the payment of dividends, that investors should keep in mind as well. Our

models do not take into account returns associated with collecting dividends in the long model or costs associated with paying out dividends in the short model.

09/01/2010 is a good example of slippage cost risk. The S&P 500 opened 09/01/2010 at 1049.72, declined for a few minutes, shot up following a positiveeconomic report at 10:00am and ended up at 1080.29. Based on where the trades were executed during the day, real returns could be drastically different than

the model returns.

Summary

These examples are not meant to be an all-encompassing explanation of risks involved in executing a model strategy in reality. As always, we urge investors to

use their own judgment.




METHODOLOGYAscendere Associates LLC quantitative research is based on several factors, including: 1) operating momentum 2) fundamental quality 3) analyst revision

momentum; and 4) relative value. A number of these factors are overweighted on what we consider proxies for cash flow growth and return on invested capital.

In our opinion these factors provide a good reflection of a company's value relative to other companies in its sector. Daily return data of our backtests are

available to paying subscribers upon request.

In our opinion, cash flow growth and return on invested capital are the key drivers of any stock's valuation. By focusing on various proxies for these data points

and other factors such as relative value, we have been able to generate some terrific investment ideas and avoid some significant value traps over our career in

sell side and buy side equity research.

For those interested in learning more about determining a company's value as it relates to ROIC, we recommend reading McKinsey & Company's "Valuation:

Measuring and Managing the Value of Companies" or "The Value Sphere: The Corporate Executives' Handbook for Creating and Retaining Shareholder Wealth."

We also find the newsletters produced by Michael Mauboussin, the Chief Investment Strategist at Legg Mason Capital Management, an excellent source of

information as it relates to determining the value of companies.

http://rcm.amazon.com/e/cm?lt1=_blank&bc1=000000&IS2=1&bg1=FFFFFF&fc1=000000&lc1=0000FF&t=reflectionone-20&o=1&p=8&l=as1&m=amazon&f=ifr&md=10FE9736YVPPT7A0FBG2&asins=0470424702






http://lmcm.com/differentiated_thinking/tlf_archive.aspx










DISCLOSURESAscendere is in the business of providing equity research and related consulting services to investors and their advisors. The equity research it provides includes

basic quantitative model portfolios and more detailed fundamental research with respect to individual stocks. In addition, the firm manages stock portfolios for

itself and clients.

Ascendere does not rate stocks on any scale, but does offer individual stock commentary and valuation opinions. With regard to Ascendere's portfolio

strategies, "long" or "high-quality" baskets should generally be considered buys, unless otherwise noted. Stocks in our "short" or "low-quality" baskets should

generally be considered sells, unless otherwise noted. While exceptions may occasionally occur, typically stocks in the high-quality basket are expected to

outperform the S&P 500 over a month's time and stocks in the low-quality basket are expected to underperform. A more relevant benchmark would comprise

of all stocks and ADRs that trade on major U.S. stock exchanges with a market cap above $2 bi llion.

Ascendere adheres to professional standards and abides by codes of ethics that put the interests of clients ahead of its own. The following are specific

disclosures made by Ascendere:

1) Ascendere may have a financial interest in the companies referred to in this report ("the Companies"). The research analyst covering the Companies

and members of the analyst's immediate family have a financial interest in one or more of the Companies.

2) Ascendere generates revenue from research subscription revenue and portfolio management fees. At any given time it may be long or short any of the Companies.

3) Ascendere does not make a market in the securities of any of the Companies.

4) Ascendere has not received compensation from the Companies.

5) Ascendere has not managed or co-managed a publ ic offering for any of the Companies.

6) Neither Ascendere nor any of its officers or any family member of the covering analyst serve as an officer, director or advisory board member of any

of the Companies.

7) Neither Ascendere nor any of its officers or any family member of the covering analyst beneficially own 1% or more of any class of securities of any of

the Companies.

8) The covering analyst certifies that this report accurately reflects such analyst's personal views.




DISCLAIMERSThis report is intended for informational purposes only and does not constitute a recommendation, or an offer, to buy or sell any securities or related financial

instruments. The report is not intended to be in furtherance of the specific investment objectives, financial situation, or particular needs of any individual

recipient. The information contained herein accurately reflects the opinion of Ascendere at the time the report was released. The opinions of Ascendere are

subject to change at any time without notice and without obligation or notification. The officers, affiliates or family members of Ascendere Associates may hold

positions in the securities of the Companies. No warranty is made as to the accuracy of the information contained herein. This information is intended for the

sole use of clients of Ascendere. Any other use, distribution or reproduction is strictly prohibited. Investing in stocks includes a high degree of risk, including the

risk of total loss.




About Ascendere Associates LLC

J. Stephen Castellano – founded Ascendere Associates LLC to provide cutting-edge equity research that blends fundamental and quantitative

approaches to generating long and short idea generation for the short- and long-term investor.

In general, our approach is quite simple -- we believe that return on invested capital and long-term earnings growth are key to stock valuation.

More granularly, we use powerful and unique financial models that combine publicly avai lable data, consensus estimates and our own inputs to

generate consistent and actionable stock recommendations.

Among the services that Ascendere provides are: 1) detailed custom equity research analysis 2) valuation scenario analysis studies

3) supply/demand studies 4) long and short stock idea generation 5) portfolio feedback 6) detailed fundamental financial modeling services; and

7) additional services. Additional information is available at www.ascenderellc.com.

Mr. Castellano has over 15 years diversified experience in finance and consulting. At PaineWebber, Warburg Dillon Read and Credit Lyonnais

Securities he developed fundamental equity valuation models and conducted in-depth equity research on the steel and telecom services industries.At Boston Private Value Investors, he developed quantitative models for stock idea generation and also provided general fundamental equity

research coverage. Steve received a MBA from the F. W. Olin School of Business at Babson College (2005) and a BA from Oberlin College (1993).

Mr. Castellano's career history is highlighted below:

Ascendere Associates, LLC (2009-Present)

Boston Private Value Investors , Equity Research, Equity Research Analyst (2005-2009)

Pyramid Research, Contract Consultant, Telecom Services (2002-2003)

Credit Lyonnais Securities (USA), Equity Research, Telecom Services, Vice President (2000-2001) Warburg Dillon Read, Equity Research, Telecom Services, Research Associate (1999-2000)

PaineWebber, Equity Research, Steel and Nonferrous Metals, Research Associate, Editor (1995-1999)





Documents

Ascendere Monthly Update — Sep 30, 2010 -- Rebalance All Long/Short Model Portfolios