Return of the Active Manager:A Behavioral Approach

March 26, 2020

C. Thomas Howard, PhD Emeritus Professor of Finance, University of Denver Chief Investment Officer, AthenaInvest

Steve Bogosian Director of Sales, AthenaInvest

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✓ Today’s Challenging Environment

✓ What is Behavioral Investing

✓ Investor Cognitive Errors

✓ Behavioral Wealth Advisor

✓ Selecting and Evaluating Managers

✓ Behavioral Investment Management

✓ Conclusions

Today’s Discussion

TODAY’S CHALLENGING ENVIRONMENT

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Today’s Environment

✓ This is an extreme and, as a result, very emotional market

✓ The current situation challenges our ability to separate our personal feelings from the advising and investing decisions we need to make

✓ At times like this it is important to keep your hand firmly on what data is available

✓ Taking a behavioral investing approach on the rebound is a smart move and that’s what we’re talking about today

Active Management in Recovering Markets

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WHAT IS BEHAVIORAL INVESTING?

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KEY CONCLUSIONS

PEOPLE ARE NOT RATIONAL

MARKETS ARE NOT EFFICIENT

THESE BUILT THE FOUNDATION FOR

BEHAVIORAL

PORTFOLIO MANAGEMENT

Nobel Prize Recognizes Behavioral Researchers

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Robert

ShillerMarket Volatility

2013

Daniel

KahnemanProspect Theory

2002

Richard

ThalerBehavioral Nudging

2017

AthenaInvest Foundation and Research

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C. Thomas

Howard, PhDEmeritus Professor of Finance

University of Denver

Chief Investment Officer

Patented

Behavioral Research

Six US and International Patents

STRATEGY

CATEGORIES

MARKET

BAROMETERS

FUND AND

STOCK RATINGS

1. Market prices are dominated by emotional crowds.

2. Behavioral research reveals unique market opportunities.

3. In large part, emotions determine investment outcomes.

4. Behavioral management can dramatically improve investment success.

Behavioral Foundational Concepts

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INVESTOR COGNITIVE ERRORS

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Old

Has not evolved in 150,000 years

Hungry

Consumes 20% of our daily energy but is only 3% of body weight

Impatient

Optimized to survive the threats faced 150,000 years ago

The Human Brain

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The Behavioral Investor by Daniel Crosby (2018)

Our 150,000-Year-Old Brain

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THREAT RESPONSE

Cognitive Reaction

• Higher-level functions

decrease

Physical Reaction

• Breathing accelerates

• Blood pressure rises

• Primed for action

FAST AND AUTOMATIC

PLEASURE

Cognitive Reaction

• All brain areas

contribute

SLOW AND COMPLEX

• Threat detection

• Process positive stimuli

• Emotional memories

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Investor Cognitive Errors

The Undoing Project by Michael Lewis (2016)

Myopic Loss Aversion

Social Validation

Availability Bias

Availability Cascade

Representativeness

Framing

WYSIATI

Anchoring

Fallacy of Information

Fallacy of Control

Peak-end Memories

Fooled by Randomness

Phantastic Objects

BEHAVIORAL WEALTH ADVISOR

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Creating High-Confidence Outcomes

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Portfolio Planning Framework – Separation of Concerns

Stable PrincipalGOAL

Loss of ValueBIGGEST RISK

Accumulate WealthGOAL

UnderperformanceBIGGEST RISK

Fund Ongoing NeedsGOAL

Decrease in PayoutBIGGEST RISK

LIQUIDITY INCOME GROWTH

Risk in Growth Portfolios

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Sources: AthenaInvest, Thomson-Reuters Financial, Center For Research In Securities Prices, St Louis Federal Reserve FRED data base.

True RiskInGrowthPortfolio

$13,659,117 (11.0%)

$454,595 (5.7%)

$165,148 (4.1%)

$79,714 (3.1%)$0

$2,000,000

$4,000,000

$6,000,000

$8,000,000

$10,000,000

$12,000,000

$14,000,000

$16,000,000

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Asset Class Returns: $10,000 Invested in 1950 - 2019

S&P 500

T-Bond

T-Bill

CPI

T-Bills are the riskiest investment

What goes down must go up

Risk is leaving money on the table

SELECTING AND EVALUATING MANAGERS

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We ask portfolio managers

to focus on a number of things

other than performance.

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Closet Indexing Factory

MPT Tools

Regulations

Business Risk

Suitability

Grievances

Volatility as risk

Diversification

Tracking error

Emotional reaction

to volatility & tracking error

creates business risk

for the company.

Making of the Closet Indexing Factory

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Behavioral Finance

Discard MPT Tools

Manager Behavior

• Past performance

• Sharpe Ratio

• Tracking Error

• Style Drift

• Strategy

• Consistency

• Conviction

Avoiding the Closet Indexing Factory

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Patented Mutual Fund Categorization Methodology

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Competitive Position Profitability

Economic Conditions Quantitative

Future Growth Risk

Market Conditions Social Considerations

Opportunity Valuation

Strategy Peer Groups

Strategy Consistency Impact on Fund Performance

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-1.11

-0.66

-0.10

0.16

1.01

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

1 2 3 4 5

An

nu

al F

un

d A

lph

a

Strategy Consistency Quintile

Strategy Consistency is measured as the % of own strategy stocks held by the fund. Sample includes US Equity Funds from 1997-2017, resulting in 288,000 fund-month observations. Sources: Morningstar and AthenaInvest.

Based on single variable, subsequent gross fund alpha regressions estimated using a data set of 44 million stock-month equity fund holdings over Jan

2001- Sep 2014.

6.1

2.3

-4.7-6

-4

-2

0

2

4

6

8

Top 10 Next 10 20+

BP

Incre

ase F

und A

lpha /1%

wt

Incre

ase

Investing in High Conviction Stocks

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AVERAGE LENGTH OF ACTIVE EQUITY FUND UNDERPERFORMANCE / OUTPERFORMANCE (2003 – 2017)

How Long can a Good Fund Underperform its Benchmark?

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Source: How Long Can a Good Fund Underperform Its Benchmark, Paul D. Kaplan, Ph.D. and Maciej Kowara, Ph.D., Morningstar Manager Research, March 20, 2018

The 3 Year decision

BEHAVIORAL INVESTMENT MANAGEMENT

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2.2

7.4

9.4

14.8

19.0

0

5

10

15

20

25

T-Bills S&P 500 Best Funds Best Stocks Best Markets

Ann

ua

l R

etu

rn

For the period April 1997 through December 2016 For details regarding truly active funds (DR5 funds), Best Idea Stocks (DR5

stocks), and Best Markets, visit AthenaInvest.com. Data sources: AthenaInvest, Thomson Reuters Financial, and Lipper

Conviction

TrackingError

LeverageEmotional Triggers

Volatility

Behavioral Investing Opportunities

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Analyst Confidence

Creditor Confidence

Manager Confidence

Athena Behavioral Investing: Pure Valuation|Profitability

Stock Picking:

• Traditional valuation combined withbehavioral factors

• High Conviction (10 stocks)

• Rules-based purchase and sell decisions

• Unconstrained

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Importance of Tail Events (Positive Skewness)

-80 -30 20 70 120 170 220

Return

Pure Stock Matched Net R2K Returns (99 stocks July 2002 - June 2019)

Patiently Harness Tail Events

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29

Tactical Strategy - Expected Market Returns

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Morningstar Category: Tactical Allocation Funds

Global Tactical ETFs Peer Group Comparison (as of 12/31/19)

30

Inception-to-Date vs. Peer Group

Athena GT 17.8%

High 10.2%

Average 5.3%

Low 0.9%

Ratings & Rankings vs. All Mutual Funds

#173 out of 12,261 Mutual Funds

0

2

4

6

8

10

12

14

16

18

20

An

nu

aliz

ed R

etu

rn %

98TH

P e r c e n t i l e

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✓ View advising and investing through the lens of behavior

✓ Separate long and short-term needs to minimize emotional impact of volatility

✓ Avoid closet indexers and the closet indexing factory

✓ Strive for excess returns through truly active management

✓ Let your managers ROAM!

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Conclusions

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Wow! I expected a terrific book from Howard and Voss, but

ROAM knocked me back. It’s a once-a-decade genre-

defining must-have-on-every-investor’s-bookshelf type of

book. Read this and your wealth (and life!) will be wiser and

smoother for it.

Richard L. Peterson M.D., author of 'Inside the Investor’s

Brain' (Wiley, 2007) and CEO of MarketPsych

Advisors – drop everything and read this book!

Barbara Stewart, CFA, Author of the Rich Thinking

series of white papers on women and finance

Voss and Howard shine a practical light on the massive

opportunity that exists for truly active fund managers in this

day and age – if they are willing to focus on identifying and

mitigating their own behavioral biases, in addition to

exploiting those of other market participants. It's a must-read

for all next-generation fund managers.

Clare Flynn Levy, Founder & CEO, Essentia Analytics

Get the Book at Amazon

Behavioral Viewpoints – Athena’s Unique Perspective

33

Focused on Behaviors

❑ We take a behavioral view of the markets and financial advice.

❑ The AthenaInvest investment process is based entirely on behavioral factors.

❑ The Viewpoints section of our website is a valuable resource for unique behavioral perspectives.

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34

“In large part, emotions determine investor success.”

Tom Howard, PhD, CEO and Chief Investment Officer, AthenaInvest

Questions ?

Contact Us

Tom Howard tom.howard@athenainvest.com

Steve Bogosian stephen.bogosian@athenainvest.com

www.AthenaInvest.com

Get behavioral insights straight to your inbox :Register at www.athenainvest.com/register

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RISKS: An investment utilizing our investment methodology involves risks, including the risk of loss of a substantial portion (or all) of the amount invested. There is

no assurance that the investment process outlined in this document will consistently lead to successful results.

You should consider the investment objectives, risks, charges, and expenses carefully before investing.Athena fact sheets contain this and other

information and may be obtained from AthenaInvest by calling (877) 430-5675 or visiting us online at www.athenainvest.com. Please read the fact

sheets or prospectuses carefully before investing.

• Some figures shown are pre-inception research results. Hypothetical or simulated performance results have inherent limits. Unlike an actual performance

record, simulated investments do not represent actual investments.

• Some figures shown are past results. Past performance does not guarantee or indicate future results.

• There are risks involved with stock investing, including the risk of loss of principal. There is no assurance that the investment process will consistently lead to

successful results.

• Opinions and forecasts regarding industries, companies, countries and/or themes, and portfolio composition and holdings, are all subject to change at any time,

based on market and other conditions, and should not be construed as a recommendation of any specific security.

INDEX DEFINITIONS

Indices used in this presentation are for comparative purposes only. Index performance does not reflect fees, expenses, or taxes and it is not possible to invest

directly in an index.

For more information please call (877) 430-5675 or visit us online at www.atheninvest.com.

Copyright © 2020 AthenaInvest, Inc. All Rights Reserved. US Patents 7734526, 8352347, 8694406 | Singapore Patents 150371, 184692 | Taiwan Patent 200828170

Important Information

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