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The Whaley Report: Good men prefer to be accountable

The week’s title is a quote from Sir Michael Edwards, a South African business executive who had a reputation during his career for publicly holding people accountable who were not accustomed to accountability.

My Old Man always stressed the importance of taking accountability and more importantly, being proactively accountable before someone else demands it of you.

This idea of accountability is so ingrained in me that it drives me nuts when people avoid accountability, which is prevalent on Wall Street and in the newsletter industry.

Accountability is the reason I give a specific bias for every Focus Market each week.  Even a NEUTRAL bias is me taking a public stand on a particular market.

Accountability is the reason I give specific price levels for entering and exiting every single trade idea.  What’s more important in trading than the price in which you enter and exit trades?

Accountability is the reason I diligently track the performance of every single trade idea that could have been executed in real-time.  What good would it do you if I throw trade ideas at you constantly but never monitor which ones could have been executed and how they performed?

Accountability is the reason that every single closed trade idea is posted to the Market Intelligence Center website for the world to see.  Anyone can visit the site and see which Focus Market we traded, the publication date of the recommended trade idea, the entry and exit price, and the resulting performance.

In this week’s commentary, I put on the big-boy pants of accountability by evaluating all aspects of The Whaley Report’s performance over the last year.

Winners and Losers

This performance review requires that I honestly evaluate my trade ideas, most importantly, the trades that turned out to be wrong. Generally speaking, 55% of my trade ideas turn out to be losers. From that perspective, my batting average was slightly better during 2016, with just 48% of my trade ideas being losers. That said, this ratio of losers to winners is right within the bounds of what I would expect from my 3G framework.

The one trade stat that took a step back during this year was the ratio of average profit per winning trade ideas to the average loss of losing trade ideas, which is approximately 2.1%-to-1.1%. The reason I’m disappointed is because while my losing percentage stayed at its’ historic average of 1.1%, the average winning percentage declined 70 basis points from my historic average of 2.8%.

The reason for the decline in profitability per winner is because I held trade ideas too long. Coming into this year, the average duration of a trade idea was 24 calendar days and during 2016, the average duration jumped to 39 days.

Specifically, I held on too long to our LONG gold and US Treasuries ideas, which were both initiated in March. While we closed both trades with a profit, we gave back approximately 4% of our profits by holding them a month longer than we should have.

Of course this is all hindsight but it’s this type of evaluation that will help me to improve the framework and improve the quality and profitability of the trade ideas moving forward.

In the evaluation of your own investment decisions, you want this ratio to be closer to $3-to-$1. A ratio in this range tells you two things. First, it tells you that you’re keeping your losers in check. Minimizing losses is the key to consistent investment results because it is the only part of a trade that you can control. Second, it tells you that you are focused on good ideas where the reward-risk set up is tilted in your favor.

Kicking Butt and Taking Names

TWR performed extremely well when compared to professional mutual fund and hedge fund managers. You may notice that I always compare how I do to real money managers, not other newsletter writers. This is purposeful.

As an investor, you want to take advice from people who actually manage real money in real time. People can’t possibly provide good insight into how markets work and how to trade them without knowing what it’s like to risk real money.

I hate to be the bearer of bad news but most newsletter writers don’t manage real money. To me, if you’re going to use my information to manage your investments then you deserve to know how my trade ideas stack up against professional investors, not how they stack up against a dentist turned financial newsletter writer.

Without further delay, here’s a breakdown of TWR’s performance relative to the competition. My 2016 performance puts TWR in the:

Top 24% of all 25,150 mutual funds tracked by Morningstar.

Top 2% of all 412 mutual funds tracked by Morningstar in their “Alternative” category.

Top 8% of all 463 mutual funds tracked by Morningstar in their “World Allocation” category.

Top 13% of all 305 mutual funds tracked by Morningstar in their “Tactical Allocation” category.

TWR’s outstanding relative returns become even more impressive when you factor in the minimal time commitment (a new trade every three weeks) and low commission costs of implementing the trade ideas.

While I’m excited about the 2016 performance, I am equally impressed with the consistency that I have been able to deliver to my readers. In addition to posting positive performance each calendar year since 2012, TWR has consistently outperformed the majority of mutual funds.

When I compare my returns to the 25,150 mutual funds tracked by Morningstar, I outperformed 73% of all funds over the last year, 99.5% over the last three years and 98% of funds over the last 4 years.

TWR also outperforms the average hedge fund manager as well. According to Barclay Hedge, TWR’s returns have outperformed the Barclay Hedge Fund Index over the last four years.

Our 10.2% return over the last year outperformed this index by 6%. TWR’s 13.3% annualized return over the last three years outperformed the HF index by 10% and our 16.4% annualized return over the last four years eclipsed the HF index by 12%!

I share these relative performance numbers with you so that you can see how TWR stands up against the track record of professional money managers but be careful about using relative performance as the sole measure of a money manager’s skill.

Great relative performance is good but unfortunately you can’t spend relative performance. When you judge anyone’s returns, make sure that the absolute returns are solid. It doesn’t matter how someone did in comparison to a benchmark or to another money manager if their calendar year returns aren’t getting you paid.

Not Created Equal

Great relative returns are nice and great absolute returns are essential but anyone who has read my commentaries for some time knows that everything I evaluate begins with understanding risk.

From a perspective of drawdown risk, all returns are not created equally. You should judge the returns of money managers based on the amount of risk you have to bear in order to earn the returns.

As a quick example let’s look at the returns of the S&P 500 Index.

During 2016, the S&P 500 has returned 13.1%, with a peak-to-trough drawdown of 10.3%. Over that same period of time, TWR has returned 10.9%, with a peak-to-trough drawdown of 4.3%. For this year alone, the S&P 500 has had a reward-to-drawdown ratio of 1.3-to-1, where TWR’s ratio is 2.5-to-1.

Which do you prefer? Profit potential that is equal to the downside risk or profit potential that is 2.5 times the potential downside risk?

But it’s not just the last year where TWR’s returns shine in terms of drawdown risk.

Since TWR’s inception on December 17, 2012, the S&P 500 has returned a cumulative 71%, with a maximum drawdown of 13%. TWR has returned just over 84% cumulatively with a maximum drawdown 10.3%.

The executive summary is that TWR has outperformed the S&P by 13 percentage points with less drawdown risk, proving that not all returns are created equal.

The bottom line is that there are very few professional money managers, or newsletters, can even come close to the level and consistency of TWR’s returns. I would encourage you to engage in a similar evaluation of your own investing process and any money managers you currently have helping you manage your portfolio. The best time to refine your process is when the markets are closed and there is no capital at risk. You need to be sure to put yourself in an objective position to evaluate your process. Strip the emotion out of it and evaluate each step looking for improvement, however minor. Even minor improvements can add up to significant improvements in portfolio performance. Here’s to wishing you a prosperous year of trading in 2017!

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Landon Whaley

Landon Whaley is the Founder and CEO of Whaley Capital Group. Mr. Whaley launched Whaley Capital Group in the aftermath of the 2008 Financial Crisis because he wanted to provide real value and a unique client experience in an otherwise highly commoditized industry. Whaley Capital Group delivers on this mission by following a rigorous investment strategy that is committed to a global macro-style of investing, while simultaneously providing a world-class, boutique-style client experience. You can contact Landon at: landon@whaleycapitalgroup.com