LC DIVERSIFIED STRATEGY OVERVIEW

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1 LC DIVERSIFIED STRATEGY OVERVIEW NOTE: This document is intended to provide only a basic overview of the LC Diversified Investment Strategy and is not intended to take the place of advice your particular investment advisor may have for you, nor is it intended to be construed as investment advice. You should only utilize this strategy after discussing it with your advisor. All investments carry risk, and an investment in LC Diversified is no different. You could lose money by investing in it, or any other, investment strategy. 1

2 Strategy Name: Strategy Manager(s): LC Diversified Jesse Blom Christopher Welsh Minimum Investment: $20, Investment Advisor: Fee: Investment: Redemption: Taxes: Lorintine Capital, LP One point five percent of assets under management (1.5% AUM), however the fee may be reduced for larger accounts (those in excess of one million dollars) An investment in the strategy may be made at any time. There is no lock up period and funds may be redeemed at any time. However, all redemptions made within six months of account inception are subject to a minimum pro-rated management fee calculation of six months as well as applicable Federal laws and securities regulations regarding trade clearing and holding periods. Please contact the strategy managers with any questions you may have about redemptions. LC Diversified is managed in the most tax-efficient way possible, including tax loss harvesting techniques, but will still produce a combination of short term and long term gains and losses. All potential investors are advised to get advice from a tax professional before investing in this, or any other, strategy. LC Diversified Background and Philosophy: Diversification is a financial concept broadly accepted, yet commonly misunderstood by most individuals including the vast majority of financial advisors. The traditional equity concentrated 60/40 blended portfolio of small cap stocks, large cap stocks, foreign stocks, and bonds offers limited equity bear market protection. Traditional methods of diversification with stocks and bonds often act like a seat belt that works at all times except during an accident. True diversification is valuable at all times, including when it s needed most. Similarly, true diversification does not mean an investor must accept lower returns by increasing holdings in US Treasuries or other low yielding securities. Rather, true diversification increases a portfolio s expected return for any given level of risk. A truly diversified portfolio may historically only have been achievable by large institutions, hedge funds, endowment funds, and ultra high net worth individuals. However, over the last few years many alternative strategies have become available in advisor directed investment accounts through traditional mutual funds and ETF s. The Yale and Harvard endowment funds have represented the virtues of diversification and alternative investment 2

3 allocation where from , the Yale Endowment returned 16.62% per year. Over that same period, in one of the greatest bull markets in US History, the S&P 500 returned only 11.98%. This 38% increase in annualized performance was also done with a 33% decrease in annualized volatility. A $100, investment in 1985 in the Yale Endowment would be worth over $4.0 million dollars in 2008 while only being worth $1.5 million in the S&P 500. Mebane Faber and Eric Richardson wrote an excellent book called The Ivy Portfolio that we highly recommend for more information on the successes of endowments like Yale and Harvard. The most powerful tool an investor has working for him or her is diversification. True diversification allows you to build portfolios with higher returns for the same risk. Most investors are far less diversified than they should be. They are way over-committed to stocks. -Jack Meyer, former manager of the Harvard University endowment fund. Most portfolios are either highly concentrated in stocks, and thus subject to high risk and dependence on economic growth; or over committed to bonds, and thus subject to lower expected returns and interest rate risk in a current environment of historically low yields. The solution we offer to our clients is a broadly diversified portfolio solution we call LC Diversified ( LCD ). The objective of LCD is not to beat an index such as the S&P 500. Rather, its objective is to provide a return stream largely independent of economic environments. In finance, this is called absolute returns. From the perspective of long-term historical risk and return characteristics of US stocks and bonds the long-term goal of LCD is to produce stocklike returns with bond-like volatility. Risk Management and Diversification: Of all the important factors involved with investing, we believe none are more important than discipline, risk management, and diversification. This extraordinary achievement quite naturally attracts all the attention, yet close observers can say that the real secret to Yale s remarkable success is defense, defense, defense. But how, you might ask, can defense be so important to Yale s remarkably positive results? Starting with that great truism of long-term success in investing - if investors could just eliminate their larger loses, the good results would take care of themselves - we remind ourselves of the great advantages of staying out of trouble. -Charles Ellis, Yale Investment Committee Chairman The first rule is not to lose. The second rule is not to forget the first rule. -Warren Bufftett I always say that you could publish my trading rules in the newspaper and no one would follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80% as good as what we taught our people. What they couldn t do is give them the confidence to stick to those rules even when things are going bad. -Richard Dennis 3

4 Every G-7 country has experienced at least one period in its history where stocks lost 75% of their value. An investor who loses 75% of their wealth is required to gain back 300% just to break even the equivalent of compounding at 7% annually for more than 20 years. Rarely do investors have this kind of patience or investment time frame to recover losses. LCD is quantitatively developed and systematically executed with a risk balanced blend of trend, momentum, and non-directional equity, options, and futures strategies that hold both long and short positions that vary across time-frame and holding periods. We believe risk management and true diversification is achieved in three primary ways: 1. Asset class diversification: This is the only form of diversification traditional portfolios have, and they still fail the asset class diversification test with only exposure to stocks, bonds, and cash and therefore excluding real assets such as real estate, inflation protected securities, commodities, precious metals, and currencies. LCD utilizes all of the above mentioned asset classes. 2. Strategy diversification: (long only, long/short, long/hedged) By adding short and hedged investments to a portfolio in a systematic way diversification is significantly increased. Over the long haul, short trades have modest expected contributions to returns as they have limited potential gains (markets can only go to zero whereas uptrends are theoretically unlimited) but they can substantially reduce risk and at certain times account for the majority of gains is a recent historical example where a global sell-off can cause correlations among asset classes to reach unusually high levels. When virtually every major asset class goes down, a portfolio diversified only by owning different asset classes can still experience large losses that can cause many investors to abandon their long-term plan. 3. Timeframe diversification: Strategies that are diversified by timeframe and holding period offer a final critical component to diversification. We believe that trading signals should analyze market trends and momentum and respond on different timeframes. LCD utilizes short term trading signals and strategies (reacting to daily price activity) out to very long term trading signals and strategies that look at cyclical trends like has occurred in US equities since Another way to achieve timeframe diversification is to have capital that only has market 4

5 exposure for brief periods of time and therefore increases the probability of missing the most harmful periods of market activity. LCD utilizes the calendar effects trading model which only has market exposure approximately 30% of the time, with the remaining 70% of the time in the safety of cash. LCD Strategic Asset Allocation: 30% LC Long Short 25% LC Managed Futures 25% LC Momentum 20% LC Select Solutions Each of the above strategies has a detailed description available directly from Lorintine Capital, on our website, at A brief summary of each strategy is as follows: LC Long Short LC Long Short has the investment objective of prosperity in equity bull markets with protection in equity bear markets. Short positions are traded with inverse mutual funds when there is a high probability of short to intermediate term equity market downside risk during extended equity bear markets such as and Long Short can potentially hold a maximum short position making up 6% of the LC Diversified portfolio. Long Short also incorporates seasonality based strategies such as Calendar Effects during equity bear markets. Seasonality is the tendency for markets of all kind to perform better than average throughout certain points of the year. Calendar Effects goal is to be invested only during the short periods of time during the year that have historically shown a high probability of profit. There are about 14 of these periods every year, leading to only 75 days of market exposure. Sector rotation relative strength strategies have long been established as a highly profitable investment method. LC Long Short incorporates a risk managed sector rotation model that invests in either high-ranked U.S. equity sectors, or in high-ranked U.S. bond sectors. At the start of each quarter a risk measurement is made to determine whether the model will invest in equity sectors or bond sectors during that quarter. When invested in equity sectors, reallocation of the portfolio is made monthly. When invested in bond sectors, a reallocation of the portfolio is made quarterly. LC Managed Futures The LC Managed Futures model is predominately allocated to trend following asset managers. Trend following utilizes a timeless philosophy of cutting your losses short, and letting your profits run by quantitatively identifying price trends in equities, interest rates, currencies, and commodities. By using mutual funds, an investor gains exposure to a strategy with a smaller minimum investment than would be typical for most trend following investment 5

6 managers. Diversified trend following seeks to generate returns uncorrelated to traditional asset classes by trading across global futures markets with positions that are both long and short. LC Managed Futures also allocates to managers employing higher frequency short term futures trading as well as non-directional options trading to add diversification by strategy, timeframe, and holding period. LC Momentum Eugene Fama, the 2013 co-recipient of the Nobel Prize in Economics and father of the efficient market hypothesis, has three words to describe momentum: momentum is pervasive. The evidence of momentum is supported by over 300 published academic papers since Yet, despite momentum being pervasive, it remains largely misunderstood and underutilized by investors. LC Momentum takes the framework of a balanced 60/40 portfolio and applies dual momentum (i.e. relative strength combined with trend following momentum) to the following asset classes: 1. The S&P 500; 2. US Small Cap Stocks; 3. All-world ex-us Stocks; 4. US Aggregate Bonds; 5. Investment Grade Bonds; 6. High-Yield Junk Bonds; 7. Long-Term Treasuries; 8. Real Estate; 9. Gold; and 10. Treasury Bills We anchor our 60/40 portfolio framework with dual momentum applied to equities (1-3) since they provide the highest expected returns of any asset class over the long term. When equities have negative absolute momentum over the prior year aggregate bonds are then used for protection until absolute momentum once again turns positive. We discussed this method in more detail in our paper, Momentum: The Premier Market Anomaly. The remaining 40% of our model then applies dual momentum to investment grade and high yield bonds (5-6) as well as to long term treasuries, real estate, and gold (7-9). Positions are reconstructed monthly. LC Select Solutions The remaining 20% of our LC Diversified portfolio includes a permanent allocation to four actively managed third party mutual fund strategies that are available only in advisor directed brokerage accounts. In line with our firm s philosophy, each of these four strategies are quantitative (rules based) in nature, and add additional diversification to the portfolio. 6

7 LC Select Solutions - AQR Risk Parity II HV Fund Risk parity is another example of maximizing return per unit of risk through better diversification. The traditional 60/40 (stocks/bonds) portfolio is essentially putting all your eggs in one basket because over 90% of the portfolio volatility comes from stocks. A 60/40 portfolio has historically maintained more than a 95% correlation to the stock market making a 40% allocation to bonds largely irrelevant. Risk Parity portfolios rely on risk-based diversification, seeking to generate both higher and more consistent returns. The typical Risk Parity portfolio begins with a much lower exposure to equities relative to traditional portfolios, and invests significantly more in other asset classes. The key to Risk Parity is to diversify across asset classes that behave differently across economic environments. In general, equities do well in high growth and low inflation environments, bonds do well in deflationary or recessionary environments, and commodities tend to perform best during inflationary environments. Having balanced exposure to these three main asset classes can produce more consistent long-term results. LC Select Solutions - AQR Style Premia Fund AQR launched their style premia alternative fund to provide financial advisors access to systematic investment styles that, based on empirical research, have generated long-term positive returns in a wide cross section of asset classes. Four investment styles Value, Momentum, Carry, and Defensive have emerged as compelling sources of alternative returns, backed by economic theory and decades of data across geographies and asset groups. When applied as long-short strategies, these styles have delivered positive long-term returns across multiple asset groups and markets, with low correlations to other investments. A multi strategy combination of styles across asset classes has performed even more consistently. However, despite a wealth of evidence for their efficacy, there have historically been few options for investors to gain pure exposure to diversified styles in a market neutral, multi-asset context. Value The tendency for relatively cheap assets to outperform relatively expensive ones. Momentum The tendency for an asset s recent relative performance to continue in the near future. Carry The tendency for higher-yielding assets to provide higher returns than lower-yielding assets. Defensive The tendency for lower risk and higher-quality assets to generate higher riskadjusted returns. LC Select Solutions - Longboard Long/Short Fund Since 2005, Eric Crittenden and Cole Wilcox of Longboard Asset Management have answered the question does trend following work on stocks? with a resounding yes. Over the years many commodity trading advisors, proprietary traders, and global macro hedge funds have successfully applied various trend following methods to profitably trade in global futures 7

8 markets, and LCD allocates 25% to managed futures. Very little research, however, has been published regarding trend following strategies applied to stocks. The empirical results strongly suggest that trend following on stocks does offer a positive mathematical expectancy, an essential building block of an effective investing or trading system. The primary investment objective of the Longboard Long/Short Fund is to seek long-term capital appreciation. LC Select Solutions - Swan Defined Risk Strategy (DRS) Fund The Swan Defined Risk Strategy is designed to give investors a risk managed approach to asset allocation. The goal: to achieve positive returns while minimizing the downside risk of the equity markets through a proprietary process that incorporates options hedging. The fund s investment strategy has been developed and refined since Key elements of the fund s strategy include: No reliance on market timing or stock selection Aiming to protect client assets during market downturns Diversifying with allocations designed to complement each other across a wide range of market conditions. Returns: Lorintine Capital has been offering LCD to clients as a single account total portfolio solution since 2014, therefore all prior results should be considered hypothetical. During periods prior to fund or model inceptions strategy simulations were used, which have certain limitations and actual results could have differed. Please contact us for any questions and more information on historical performance data. The below returns and statistics are presented on a best efforts basis to provide a visual representation of the benefits of diversification. Although the information provided is obtained or compiled from sources we believe to be reliable, it cannot be guaranteed. Simulated performance figures are net of a maximum Lorintine Capital management fee of 1.5% annually. Management fees are disclosed on page two of this document, in Lorintine Capital s ADV Part II, as well as in our investment advisory agreement which is a requirement to be completed by each client investing in the strategy. 8

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14 LC Diversified The power of Diversification Combining our four strategies together into LC Diversified provides a visual representation of how diversification can reduce volatility and drawdowns while increasing monthly win rate and returns per unit of risk. This is what true diversification means to Lorintine Capital. Of course, every single year there will be strategies within LCD that make substantial contributions to performance, strategies that only modestly contribute to performance, and at times strategies that even reduce total portfolio performance. There will also be times where LCD may significantly underperform market averages. This is expected and part of an absolute return profile. In the short term, the disciplined nature of diversification can feel rather boring and monotonous causing temptation to abandon the plan for what may be the investment flavor of the day. However, over the long term we believe the tortoise wins the race and LCD is a high probability bet towards a long term successful investment experience. Miscellaneous: As always, please remember that past performance is not indicative of future results. While the strategy s managers fully believe that LCD will continue to manufacture high risk adjusted returns over the long term, such results cannot be guaranteed. Any investor utilizing LC Diversified should be mentally and financially prepared to have periods of loss that could be substantial. Diversification does not provide protection against all potential loss or guarantee a profit. The managers of LC Diversified expect that the strategy s maximum drawdown is in the future. The risk and return characteristics of LC Diversified suggest that a future drawdown of 10-20% lasting 2-3 years is statistically likely at some point in the next thirty years. 1 If you have any questions regarding LC Diversified, or any other investment questions, please contact Lorintine Capital at the following: Lorintine Capital, LP Attn: Jesse Blom & Christopher Welsh 8150 N. Central Expressway, Suite 1150 Dallas, TX P: (214) P: (605) F: (214) E: jblom@lorintinecapital.com cwelsh@lorintinecapital.com 1 Based on statistical figures provided by Alex Greyserman and Kathryn Kaminski in chapter 8 of Trend Following With Managed Futures for a portfolio with an annualized volatility of 10% and Sharpe Ratio of 1. 14