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A Money Manager For Virtually Any Kind Of Market

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
January 18, 2005

IN THIS ISSUE:

1.  Third Day Advisors, LLC – Our Latest Find

2.  A Leveraged Long & Short Strategy In Equities  

3.  Impressive Results In Different Market Environments

4.  Hedge Fund-Like Strategies For Only $50,000

Introduction

As I discussed last week, “hedge funds” have been the rage in investment circles for the last several years.  However, most of these funds require minimum investments of $1 million or more, if you can get in at all.   This week I am delighted to introduce you to a professional money manager that applies some hedge fund-like strategies to mutual funds. 

The money manager discussed below is the latest to make it into the select team of successful Investment Advisors that I recommend to my thousands of clients across America.  There are tens of thousands of money managers around the country – some good, some fair and many you want to avoid – and we constantly search for those Advisors that truly bring something special to the table.  I will tell you, they are few and far between.

For over five years, we have been looking for a mutual fund money manager that has a successful performance record using hedge fund-like strategies both on the “long” side and the “short” side, and who has made money both in bull markets and bear markets in stocks.  I am happy to report that we have now found a money manager who: 1) made money in the bear market of 2002; 2) made money in the bull market of 2003; and 3) who even made money in the choppy, sideways market of 2004.

If you manage your own investments, and if you have handily beaten the equity market averages over the last several years of up, down and sideways markets, then maybe you should just skip this week’s E-Letter.  Otherwise, I suggest you read on and find out about a money manager that uses widely-known mutual funds to make money when the equity markets are trending higher AND even when the markets are trending lower.

Let me now introduce you to THIRD DAY ADVISORS, LLC and Ken Whitley , the founder and mastermind behind the system.  As you will see, Third Day has an impressive performance record.  Keep in mind, however that Third Day’s money management system is an aggressive program which uses both long and short positions.  It is therefore not suitable for all investors.  Past performance is not necessarily indicative of future returns.

Third Day Advisors, LLC

Like many active money managers, Ken Whitley began his career in an industry unrelated to financial services and asset management.  Ken graduated from college in 1981 with a B.S. in Computer Science and has spent his career in the fast-paced high-tech industry.  The saga of how Ken utilized his extensive knowledge of computer hardware and software to develop an effective money management system is very interesting, so read on.

After working for various employers in the high-tech industry, Ken joined a small software firm in 1989.  When this company’s software product was acquired by Intel Corporation in 1997, an offer of employment came with the deal.  Ken accepted the offer and is still employed full-time by Intel where he is engaged in project and engineering management.

Having enjoyed the fruits of the 1990s high-tech boom, Ken built up a nest egg that he then sought to invest.  He began studying the market in his spare time, and after much trial and error, he developed a sophisticated model for trading the Nasdaq 100 Index.  In November of 2001, Ken completed back-testing this model back to 1995 and concluded that his system had potential.  He then started trading his own money using the signals generated by his system. 

In 2003, Ken brought in Doug Fisher and his wife Angela as additional partners in Third Day.  Doug, also an employee of Intel, provides marketing assistance while Angela is responsible for day-to-day trading.  Ken and Doug’s money management activities at Third Day have been fully disclosed to Intel management, and they have no objections since their positions at Intel have nothing to do with providing investment advice.

The Third Day Aggressive Strategy

Investors familiar with alternative investment strategies, such as hedge funds, often seek out programs that can go both long and short in the market.  In such programs, the potential for profit exists no matter what the market’s direction.   Unfortunately, many such programs are available only to wealthy investors through hedge funds.  The Third Day Aggressive Strategy allows many aggressive investors the ability to have long and short exposure to the Nasdaq 100 Index.

Ken’s Aggressive Strategy is a proprietary blend of momentum, trend-following and overbought/oversold indicators.  There are six basic indicators that Ken uses to analyze the market, with a number of sub-indicators that also factor into each trading decision.  Each indicator “votes” on whether to be long, short, or neutral in the market.   The model is 100% mechanical, though Ken does reserve the right to override his system’s signals in the case of a national emergency.

The relative strength of each indicator then determines to what extent the Third Day program will be invested in the market.  The investment vehicles used are the Rydex Venture and Rydex Velocity mutual funds.  These funds are part of the Rydex Dynamic class of funds that seek to provide investment returns that correlate to 200% of the daily performance of the Nasdaq 100 Index, with Velocity providing a positive correlation and Venture providing a negative correlation.  Unlike other mutual funds, the Rydex Dynamic funds also allow Third Day to trade in or out of a fund two times per day, once at 10:45 AM Eastern time and again at the close of business at 4:00 PM Eastern time.

To limit risk, Ken will only allocate up to 75% of an account to any fund position, resulting in a 150% maximum exposure to the Nasdaq 100 market.  However, maximum allocations (75%) are rare.  Historically, Third Day’s allocations are in the maximum range only 12% of the time on the long side, and only 2% on the short side.  The program is projected to be in cash (money market fund) an average of 38% of the time in any given year based on historical performance and back-testing.

When first developed, Ken’s model would issue a trade signal that would last a maximum of three days, which is where the “Third Day” name came from.   This automatic exit from the market also acted as a method of risk control, since the duration of each trade was limited.  However, in the strong stock market in 2003, Ken found that automatically exiting the market after three days left additional gains on the table in many cases.  Thus, he adjusted the model to allow it to stay invested as long as the buy signal is confirmed by his indicators.

The Third Day Aggressive Strategy does not currently employ any traditional stop-loss techniques to automatically exit losing trades.  This is another reason why the program should only be considered by aggressive investors who are comfortable with high volatility and significant periodic drawdowns.

While the Third Day program has been successful in limiting losses, it should not be considered as a low-risk program.  While Third Day’s Aggressive Strategy has had only a –12.18% maximum month-end drawdown to-date, Ken says that his target is to limit drawdowns to no more than -20%.   You should keep this in mind when evaluating this investment for your portfolio.

The short-term trading nature of the Third Day Aggressive Strategy will mean that there will be a significant amount of activity in your account.  In addition, all gains will be short-term in nature, so this program may not be the most suitable option if tax efficiency is a priority.

Performance Evaluation

As noted above, Ken did not start actual trading of his program until the end of 2001, so it has a relatively short actual performance history.  While the track record is just over three years, 2002, 2003 and 2004 provided three very different types of markets to test his strategy.  In 2002, we saw a major bear market in stocks.  In 2003, the market reversed itself and experienced a powerful rally.  Then in 2004, we saw a sideways market where long-term trends were hard to come by.

Many times, strategies that claim to be effective in all types of markets can do well in a bull or bear market, but usually not both.  Even the ones that can negotiate both up and down markets often get whipsawed during sideways markets due to volatility and the lack of tradable trends. 

Since its inception in November of 2001, the Third Day Aggressive Strategy has proven its ability to navigate different market environments by posting an average annualized return of 23.43%, net of all fees and expenses.  The worst-ever losing period (or “drawdown”) was –12.18% in the bear market of 2002.

See the actual performance history in the tables below for more comparisons and detailed monthly returns. 

Performance Statistics
(Net of all fees and expenses)

Third Day December 2004 Performance

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Please see important notes at the end of this E-Letter.

While Third Day’s performance is impressive by itself, it’s even more so when compared to the S&P 500 Index’s average return of 6.14% and the Nasdaq 100 Index’s average return of 4.61% over the same period.  While past performance is not necessarily indicative of future results, it’s clear that Ken’s sophisticated model has been effective in dealing with very different market conditions over the past three years.

The Trading Platform

As noted above, Third Day is a small firm and Ken still has his full-time job with Intel.  However, Ken’s location on the West Coast (Pacific time zone) and his outsourcing of “back-office” operations have overcome the usual constraints associated with a small business.  Ken has the benefit of living in the Portland, Oregon area, a three-hour time difference from the East Coast.  As discussed above, the first trading opportunity for the Rydex Dynamic Funds is at 10:45 AM Eastern, which is 7:45 AM Pacific time, before Ken’s workday starts at Intel.  The second trading deadline is 4:00 PM Eastern, which is 1:00 PM in Oregon, during the lunch hour.

The luxury of the time zone differential, however, does not cover the lack of a back-office capability for processing accounts.  Third Day has also covered that base by outsourcing its back-office activities to Purcell Advisory Services, LLC, a company that provides back-office services for small Advisors nationwide.  Purcell Advisory Services handles the account set-up paperwork, reporting, fee billing, etc. while Third Day need only make a call to Purcell each day to communicate the trading instructions.

Since the system is 100% mechanical, all Angela has to do is enter market data and the software produces the actual trading instructions.  If the system gives a signal, either to enter a trade or exit a trade, Angela then confirms the signal with either Ken or Doug, and then communicates the trading orders to Purcell.

Because of this outsourcing, the ProFutures due diligence team also made an on-site visit to Purcell Advisory Services to review their administrative capabilities and internal controls.  We are happy to report that they passed our due diligence review with flying colors.

The minimum investment for the Third Day Aggressive Strategy is $50,000, and the annual fees are 2.5% billed quarterly in advance.  Client funds are held in Rydex mutual fund accounts, and investors have access to their accounts through the Rydex website.  Both Rydex and Purcell Advisory Services issue quarterly statements, and Rydex produces year-end tax reports.  

When Tragedy Strikes

One of the most important questions we ask when performing due diligence on an Advisor is to what extent they have someone to back them up should they not be able to fulfill their duties.  In most cases, we have to evaluate a hypothetical back-up plan, but in Third Day’s case, we were able to see the back-up plan in action.

In November of 2004, Ken was called home from a hunting trip due his wife’s sudden illness.  A few days later, his wife, Jane, died at only 41 years of age.  Jane had, up until that point, shared trading responsibilities with Angela.  During the period of time that Ken was attending to his wife in the hospital, and then making funeral arrangements and spending much more time with their four children, the Third Day back-up system performed flawlessly.  Ken’s partner, Doug Fisher, ran the model and his wife Angela called in the trades.

We have spoken extensively to Ken in the aftermath of his wife’s death to make sure he still wants to commit to continue his money management business.   Ken has told us that he is just as committed as ever to continue Third Day, partly because his wife was an integral part of founding the business, and she would have wanted it that way. 

Experienced investors will recognize that life-changing events, such as a spouse’s death, can have an effect on an Advisor’s continued success.   We recognize this factor and will stay in close contact with Ken in the weeks and months ahead.  However, with the 100% mechanical nature of the system and the proven back-up in the form of Ken’s partners, we feel that the Third Day program continues to be a viable option for our aggressive clients.

Conclusions

The Third Day Aggressive Strategy can be an attractive option for investors who understand risk and want to diversify their portfolios by adding an investment that has both a long and short exposure in the market.  As noted above, the program has an average annualized return of 23.43%, net of all fees and expenses, with a worst-ever drawdown of only –12.18%. 

Yet the most impressive thing about this program is that it has shown outstanding results during the last three years of very different market conditions.  And you can access Third Day for a minimum investment of only $50,000.

Our analysis has also shown that Third Day’s historical returns show little or no correlation to the other Advisors I have written about over the past two years.  Thus, the Aggressive Strategy is an ideal complement to the other actively managed investments offered under the ProFutures AdvisorLink Program.

In conclusion, the Third Day Aggressive Strategy is one of the most impressive programs we have seen in several years.  Normally, we like to see a performance record that is longer than just over three years, but every successful money manager has to start somewhere.  Because the system is 100% mechanical (no discretion on Ken’s part), we have more confidence in the program going forward.

If you believe, like I do, that there is a recession in our future, and that the equity markets will face some tough times in the next several years, then I suggest that you take a serious look at Third Day’s very successful program.  Having the potential to make money in a sideways or bear market may prove extremely important over the next few years. 

If you want to learn more about the Third Day Aggressive Strategy, or have questions regarding any of the information provided in this Profile, you can call ProFutures at 1-800-348-3601, or e-mail us at mail@profutures.com

Very best regards,

Gary D. Halbert

 

SPECIAL ARTICLES

A road map to making history.
http://www.msnbc.msn.com/id/6830801/site/newsweek/

Who’s calling Bush an idiot now?
http://www.timesonline.co.uk/article/0,,1070-1443680,00.html

Let Bush be Reagan – advice from a liberal.
http://politics.slate.msn.com/id/2112266/

IMPORTANT DISCLOSURES: ProFutures Capital Management Inc. (PCM), Third Day Advisors, LLC, and Purcell Advisory Services, LLC are Investment Advisors registered with the SEC and/or their respective states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. This publication is not intended as personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. There is no foolproof way of selecting an Investment Advisor. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. PCM receives compensation from the Advisors in exchange for introducing client accounts to the Advisors. For more information on PCM or any other Advisor mentioned, please consult PCM Form ADV II, available at no charge upon request. Officers, employees, and affiliates of PCM may have investments managed by the Advisors discussed herein or others.

As a benchmark for comparison, the Standard & Poor’s 500 Stock Index (which includes dividends) represents an unmanaged, passive buy-and-hold approach. The volatility and investment characteristics of the S&P 500 or other benchmarks cited may differ materially (more or less) from that of the Advisors. Historical performance data represents actual accounts in a program named Third Day Aggressive Plan, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Purcell Advisory Services utilitzes research signals purchased from Third Day Advisors, an unaffiliated investment advisor. The signals are generated by the use of a proprietary model developed by Third Day Advisors. In all cases, performance histories reflect a limited time period and may not reflect results in different economic or market cycles. Statistics for “Worst Drawdown” are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Investment returns and principal will fluctuate so that an investor’s account, when redeemed, may be worth more or less than the original cost. Any investment in a mutual fund carries the risk of loss. Mutual funds carry their own expenses which are outlined in the fund’s prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

Returns illustrated are net of the maximum management fees, custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. Individual account results may vary based on each investor's unique situation. No adjustment has been made for income tax liability. Performance for other programs offered may differ materially (more or less) from the program illustrated. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.

Copyright © 2005 ProFutures Capital Management, Inc. All Rights Reserved.


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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