Our ongoing Q&A series features Carillon Tower affiliate managers sharing their diverse investment philosophies and thoughts on the market.
Volatility has returned to the markets and investment professionals are taking notice. We asked Abe Sheikh, chief investment officer and portfolio manager at Cougar Global, about the firm’s distinct approach to risk and its reaction to volatility.
Cougar Global offers clients access to a specialized top-down investment philosophy with a focus on protecting on the downside. Our tactical portfolios attempt to participate in bull markets, while trying to avoid the significant financial pain associated with bear markets. We utilize a variation of Post-Modern Portfolio Theory: attempting to generate compound growth for clients, primarily by avoiding loss of principal. The recognition that asset classes behave differently depending on how investors react to the incoming macroeconomic information is at the core of the Cougar Global's investment process.
In our opinion, many investors have become complacent after a prolonged equity bull market–the longest on record. Indeed, U.S. investors have experienced a decade of stellar performance after the Global Financial Crisis in 2008. After inflation, the S&P 500 Index has returned nearly 11% a year, compared to the 50-year average of 5.5%. This translates to roughly 60% more in overall portfolio value over 10 years, compared to the historical average. 1However, on most conventional metrics, U.S. stocks now (as of December 2019) trade at extremely elevated valuations. For example, measured on a price-to-sales ratio – the inverse of which has been historically well correlated to actual subsequent 10-year returns – S&P 500 valuations are near levels last seen during the dot com “bubble” of 2000. (Recall that the S&P 500 Index went on to lose close to 50% of its value over the subsequent two years.) Our view is that investors should adopt an approach that is both flexible and downside focused and one that can help weather the possible high volatility on the horizon. Hence, there is opportunity for a tactical risk-aware asset allocator like Cougar Global to add significant value to client portfolios.
We expect the U.S. economy to continue to grow at a moderate pace in 2020 – however, with elevated downside risks, particularly around the U.S.-China trade war. We see the probability of Recession in the U.S. over the next 12 months at 4%, down from 6% earlier in the summer of 2019. Several warning signs – such as an inverted yield curve – have stopped flashing red, leading to a slight reduction in our estimate. Together with our probability of Chaos (“Black Swan” event risk) at 8%, we see the probability of downside risk to the U.S. economy over the next 12 months at an elevated 12% (Recession + Chaos).
On the topic of recession, recent economic data in the U.S. – particularly on the cyclical manufacturing side – has deteriorated, diverging from more buoyant stock markets. The Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index has registered four consecutive readings of contraction (below 50). The powerful Conference Board Leading Economic Index (LEI) in the U.S. has plateaued, while the year-over-year change on the LEI has plummeted to close to zero. This cyclical economic weakness has been countered by aggressive interest rate cuts by the Federal Reserve, which succeeded in steepening the yield curve and creating a floor under stock prices (the “Powell Put”). Taken together, we believe the risk of a U.S. recession over the next 12 months is moderate, although not high at this point.
Our probability of Chaos is primarily driven by concerns around U.S.-China trade negotiations and tensions in the Middle East (particularly between the U.S. and Iran). Our other scenario probabilities in the U.S. over the next 12 months are as follows: Probability of above trend Growth at 7%, Stagnation at 78% and Inflation at 3%.
At Cougar Global Investments, our preferred risk metric is the “probability of loss” over a 12-month time horizon, using empirical return distributions bootstrapped to our expected (not historical) economic environment. As the exhibit 1 shows, we incorporate the fact that there is an asymmetric relationship between investors’ reaction to gains and losses. This is an application of Post-Modern Portfolio Theory, Rational Beliefs Theory and Prospect Theory, the latter being the pioneering Nobel prize-winning work of Daniel Kahneman and Amos Tversky. It is our attempt to overcome the shortcomings of Modern Portfolio Theory and the use of volatility as a risk metric.
Exhibit 1: Prospect theory tells us that losses are more painful than gains are pleasurable
Source: Prospect Theory by Daniel Kahneman and Amos Tversky
Rigorous research, advanced statistical modeling and macroeconomic scenario analysis are combined with the tactical use of highly liquid ETFs to create investor-centric portfolios focused on minimizing downside risk.
Cougar Global’s process allows the investment team to adapt to changing market and economic conditions by reviewing the asset mix for each strategy monthly and rebalancing as necessary.
Cougar Global Investments is a globally oriented macro asset-class portfolio manager that uses a disciplined portfolio-construction methodology which combines macroeconomic analysis with downside-risk management. Cougar Global’s guiding belief is that the goal of investing is to generate consistent compound growth, primarily achieved by seeking to minimize loss.
To learn more about Cougar Global Investments click here or contact us at 800.521.1195.
Carillon Tower Advisers is a global asset-management firm supporting autonomous boutiques spanning investment disciplines and asset classes, each with a focus on risk-adjusted returns and alpha generation. We believe this lineup of institutional-class portfolio managers can help investors meet their long-term business and financial goals. Ultimately, this structure allows investment teams to focus on what they do best: managing portfolios.
An investment in Exchange Traded Funds (ETFs) involves the risk of losing money and should be considered as part of an overall program, not a complete investment program. An investment in ETFs involves additional risks: non-diversified, the risks of price volatility, competitive industry pressure, international political and economic developments, possible trading halts and index tracking error. Performance is directly related to the performance of underlying ETFs and the ability of each strategy to achieve its investment objective is directly related to the ability of the underlying ETFs to meet their investment objectives.
Asset allocation and diversification do not ensure a profit or protect against a loss. All investments are subject to risk. There is no assurance that any investment strategy will be successful or that any securities transaction, holdings, sectors or allocations discussed will be profitable. Strategies discussed are subject to change at any time due to market conditions or opportunities. Past performance does not guarantee or indicate future results. There is no guarantee that these investment strategies will work under all market conditions. Tactical allocation investing presents specific risks, such as currency fluctuations, differences in financial accounting standards as well as potential political and economic instability. As with all equity investing, there is the risk that an unexpected change in the market or an ETF’s holdings may have an adverse effect on its value and total return. The biggest risk of equity investing is that returns can fluctuate and investors can lose money. Because these strategies normally will hold a focused portfolio of fewer holdings than many other diversified strategies, the increase or decrease of the value of a single security may have a greater impact on the total return.
This material may include forward-looking statements. These statements are not historical facts, but instead represent only beliefs regarding future events, many of which, by their nature, are inherently uncertain. You should not place undue reliance on forward-looking statements as it is possible that actual results and financial conditions may differ, possibly materially, from the anticipated results and financial conditions indicated in these forward-looking statements. There are uncertainties, unknown risks, and other factors that may cause actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these statements.
Cougar Global Investments calculates the Macro Economic Scenario Analysis (MES) by assigning probabilities to each of the five economic scenarios (Growth, Stagnation, Inflation, Chaos and Recession) over a one-year forecast horizon. The MES is based on quantitative data sourced from various firms and then weighted and may be adjusted based upon Cougar Global Investments thought capital. MES is subject to change. These are hypothetical examples and are not representative of any specific situation. Actual economic results may vary. Economic forecasts set forth may not develop as Cougar MES indicates and there can be no guarantee that these strategies promoted will be successful. Past performance is no guarantee of future results.
Macro Economic Scenarios: Growth - U.S. economy is growing at or above its potential growth rate, Recession - U.S. economy is shrinking (negative quarter over quarter growth rate), Stagnation - U.S. economy is growing more slowly than its potential growth rate, Inflation - Consumer Price Index (CPI) inflation rate is higher than U.S. economy’s potential growth rate, Chaos - A high-impact, low-probability event (aka “black swan”). Current Consensus: Wall Street Journal Economic Forecasting Survey – a survey of quarterly U.S. Real GDP forecasts over the next 12 months. Cougar Global Investments MES Source: Cougar Global Investments.
The ISM Manufacturing Index is a widely-watched indicator of recent U.S. economic activity. The Conference Board Leading Economic Index® (LEI) for the U.S. composite economic indexes are the key elements in an analytic system designed to signal peaks and troughs in the business cycle.
The statements above are based on the views of the advisor and are subject to change.
The information presented is for discussion purposes only and not an offer.
The information presented is not tax, investment or legal advice. Prospective investors should consult with their advisers.