Alpha Squared Capital

2019 – 2020 Annual Letter

May 1st, 2020

Alpha Squared Capital Clients, 

Portfolio Performance (Net of Fees)

 ASC Active GrowthASC Passive GrowthS&P 500
5/1/2019 – 4/30/2020+10.12%+8.95%-1.35%
2020 YTD (4/30/2020)+6.15%-3.05%-9.85%

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This is Alpha Squared Capital’s (ASC) 2019-2020 annual letter. Our prayers go out to everyone affected by COVID-19.

Many would assume that one of the most aggressive corrections in the history of U.S. equities would be detrimental to any young firm. However, we took this event-driven crisis as a chance to prove our investment strategy. A cornerstone of our active investment strategy is to limit downside risk through manual floating stop losses and market hedges. While outperforming during bear markets is not nearly as much “fun” as outperforming during bull markets, it is vital to long-term success. The hypothetical example below illustrates how mitigating losses can dramatically reduce the growth required to break even:

ex.: Portfolio 1 loses 25% – Requires 33.33% return to break even

ex.: Portfolio 2 loses 15% – Requires 17.65% return to break even

Portfolio performance is a focus at ASC; the term alpha, which means superior risk-adjusted return, is in our name. However, it is only one piece of the wealth management puzzle. Financial Planning is equally, if not more important. Not only do we strive to deliver alpha on client assets but also to provide industry-leading financial advice.

ASC Active Growth is our premier portfolio comprising of approximately 30 of what we believe to be the highest quality companies and Exchange Traded Funds (ETFs). Our proprietary, academia-based, and data-driven research strives to take advantage of the individual equity growth of mega-capitalization stocks with the heaviest weights in index-linked ETFs. This active strategy utilizes security hedges in an attempt to reduce risk exposure and capitalize during market uncertainty. With a diversified mix of companies in which we believe to be high quality, this portfolio intends to deliver superior risk-adjusted returns for the growth investor. Moving forward, the renamed portfolio will be, ASC Flagship.

ASC & Flagship’s first trade of this fiscal year was a short sale in May 2019. As we attempted to enter into our target portfolio throughout 2019, it wasn’t until January 2020 where we fully invested the actively managed assets. At the end of February 2020, we began selling long positions and raising cash. Our market hedge (long VIX) was trimmed too early – causing a reassessment of strategy. Short selling prevailed as additional technical indicators were violated. Reentry into a net long weight was gradual but persistent as timing a market bottom is nearly impossible. Basing buy-side entries off technical and algorithmic indicators, we were able to capture a competitive average cost basis into our selected equities and ETFs compared to the S&P 500 bottom of 2,192. In March 2020, Flagship posted a positive return while the S&P 500 posted a negative 12.5% loss. Turnover was high but irrelevant as the majority of Flagship funds are qualified.

It is important to note that Flagship returns this year suffered as a result of initial capital inflows not being allocated right away. As we continue to receive new funds, they can be swiftly allocated into the portfolio as we have fully invested all initial funds received by the firm at inception.

ASC Passive Growth portfolio seeks to outperform the performance of the benchmark index, the S&P 500. The portfolio employs a sector overweight investment approach designed to similarly track the performance of the index. The buy and hold strategy invests in passive index and sector-based ETFs by sampling the index, meaning it holds a broadly diversified collection of securities that, in the aggregate, approximates the index in terms of key characteristics. Moving forward, the renamed portfolio will be, ASC Sector Overweight Growth (SOG).

The SOG buy and hold strategy performed strongly due to equity sector diversification. The defensive sector we overweight in this portfolio did not hold up during this decline like past instances. This was due to the unprecedented economic conditions affecting the sector’s core function. However, the growth sector we overweight in this portfolio provided stability, resulting in a limited decline compared to the S&P 500. Clients who participated in dollar-cost averaging into SOG benefited from the violent end to Q1 2020 as the buying strategy specifically aims to reduce volatility.

This year markets have evolved dramatically. Until mid-February 2020, we rode the tail end of the 11-year bull market (if 4Q18 is discounted) driven by steady corporate growth and continuous inflows from domestic and foreign investors. Recently, we experienced the worst correction Wall Street has witnessed since the 2008 financial crisis. As COVID-19 spread into a global pandemic, the global economy and markets took a toll unseen since the financial crisis. Without swift global isolation, worldwide markets and GDP would likely be far worse than current. Regardless, investors are unsettled as
we approach the possibility of the next recession hastily.

As we stick to our strategy, we can navigate markets by methodically trading in an attempt to protect and grow client capital. During periods of volatility, limiting downside risk is vital, but preparing for the inevitable market recovery is equally as important. While uncertainty is much more considerable than certainty, our current outlook is: 

  • Throughout the year, there has been one global constant – the search for yield. The declining interest rate environment is driven by global central bank monetary policy to cut rates. Internationally, some nations have pushed interest rates negative. Domestically, the U.S. is still a reliable global safe haven at 0-0.25%. Complimenting this concept, the largest individual wealth holders, baby boomers, and institutional investors, like insurance companies, endowments and pensions, hold the majority of wealth. Both rely on investment income. Due to this, we foresee the global and domestic search for yield continuing.
  • Election year volatility. Once COVID-19 volatility ceases, politics will take center stage in the media. Historical data suggests that election years provide less than favorable returns. However, the data suggests the contrary to reelection years. Due to the statistics, we expect volatility but favorable returns.
  • The current uncertainty surrounding the containment time-frame of COVID-19 poses a risk to corporate earnings and GDP. The continuous spread of the virus makes it increasingly difficult to estimate the length of the pandemic. As that uncertainty persists, economic instability will exist. With the chance of a second wave spreading globally, we focus on domestic and international drug manufacturers’ progress towards providing a viable vaccine.
  • Since recovering from the 2008 financial crisis, corporate buybacks became an increasingly popular method for corporations to increase Earnings Per Share (EPS) artificially. By reducing the denominator (Earnings / Shares Outstanding), companies financially engineer higher EPS by reducing the number of shares outstanding. As of late, this strategy has faced scrutiny within the media. We disagree with the view that buybacks are detrimental to shareholders of mega-cap equities. As an example, we support Apple’s decision to announce an additional $50B in its share repurchase plan. Buybacks continue to hold weight within our fundamental screening process.
  • Lastly, stimulus deployed throughout COVID-19 came faster and in larger quantities than previous recessionary times. In an attempt to heed recession risks, the Fed launched unprecedented quantitative easing programs to help stabilize markets and the economy. The adage: “don’t fight the fed” continues to hold its historical weight. However, there is a mountain of negative economic data staring the market in the eyes. We believe much of the
    economic data provides poor indicators of equity valuations and potentially skewed data due to quantitative easing efforts. During these noisy times, we will focus on the ultimate technical indicator, price action movement.

In conclusion, as we write clients and supporters with current uncertain political, economic and market conditions, the entire ASC team optimistically looks forward to the future. Low interest rates and other quantitative easing efforts will aid an expansionary environment once uncertainty subsides. ASC will stick to our academia-based and data-driven tactics to navigate the ever-changing markets in an attempt to follow through on our mission of delivering alpha while providing an unparalleled wealth management experience. As we continue to build off the foundation we created, we look forward to working hard for our clients and building lasting relationships.

Disclosure:
The performance presented above is solely for informational purposes and represents the time period between 5/1/2019 – 4/30/2020. Actual performance levels for clients vary based on when they entered the model(s). Additionally, each model requires a certain level of assets to be accurately allocated among the selected securities. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Alpha Squared Capital, LLC unless a client service agreement is in place. Please contact us at your earliest convenience with any questions regarding the content of this letter and how it may be the right strategy for you. For actual results that are compared to an index, all material facts relevant to the comparison are disclosed herein and reflect the deduction of advisory fees, brokerage and other commissions and any other expenses paid by Alpha Squared Capital, LLC’s clients. An index is a hypothetical portfolio of securities representing a particular market or a segment of it used as indicator of the change in the securities market. Indexes are unmanaged, do not incur fees and expenses and cannot be invested in directly.

The views expressed within this letter are subject to change at any time without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security or strategy. Please contact a financial advisory professional before making any investment decisions.

Alpha Squared Capital, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Alpha Squared Capital, LLC and its representatives are properly licensed or exempt from licensure. More information about Alpha Squared Capital, LLC including our investment advisory fees are described in Form ADV Part 2 available on the Investment Adviser Pubic Disclosure website.

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Alpha Squared Capital  is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Alpha Squared Capital and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Alpha Squared Capital  unless a client service agreement is in place.