Philosophy

Inefficiency

Financial Markets Are Not Efficient.

Many adults make irrational decisions. More than 60% of adults buy lottery tickets, with terrible after-tax expected returns. Financial markets are a nexus of many adults making both rational and irrational decisions. Irrational or uninformed future expectations lead to securities that are either undervalued or overvalued. Some of the more recent examples:

1980 Savings and Loan Crisis
1987 Stock Market crash
1989 Junk Bond crash
1998 Latin American debt crisis
2000 Internet bubble and the resulting collapse
2008 Sub prime real estate bubble and the resulting collapse
Post-2008 $9,000,000,000,000 of money printed globally

Risk Mitigation.

We have limited ability to predict what financial markets will do in the future, but we know what they have done in the past. We use statistics from past market return streams to allocate assets and to control the risk we can take with client assets.

Capturing Returns

Opportunities for excess returns are out there.

Here are a few that we pursue.

Seasonality

US and foreign stocks, bonds, and commodities all follow seasonal patterns where the majority of their expected returns have been realized in a portion of the year. During those times, it makes sense to hold an increased position on the assets. During the times when the expected returns are low, it makes sense to hold smaller (or no) positions in those assets.

Individual Stocks

Long opportunities exist for some stocks with exceptionally high expected returns. Short opportunities exist for stocks with exceptionally low expected returns.

Foreign Markets

Many of the challenges that face the United States: substantial government debt, low rates of economic growth, an aging population, declining employment participation, are even worse in Japan and in the Eurozone. DCM avoids investing in countries afflicted with these problems. DCM will pursue opportunities to invest in non-Eurozone European countries and in emerging markets countries.

Losers

Certain financial products are structured to almost guarantee consistent losses year after year. It often makes sense to hold small short positions in those products.

Government Uncertainty

Government uncertainty can add to the risk associated with investing in stocks and other securities. Here are a few recent examples:

TARP Bailout
The Federal Reserve's QE1, QE2, Operation Twist, QE3, and QE4
Debt Ceiling battles between Democrats and Republicans
European Debt Crises

DCM will sometimes decrease exposure to stocks and other types of assets when government uncertainty makes the reward/risk ratio poor.

Smart Beta Index Funds

These funds take into account alternative weighting strategies rather than traditional market capitalization based indices. Read more here.

Yield Spreads

We look at the difference between the quoted rates of return on two different investments, or the yield spread. This is an indication of the risk premium for a product. Read more here.

Yield Enhancement

Interactive Brokers offers a Stock Yield Enhancement Program that allows IB customers to earn additional income. Customers can lend shares to IB for lending to short sellers who pay to borrow them. Read more here

Equity Risk Premium

We look at the yield of 10 year US treasury bonds compared to the yield of the SP500, also known as the Equity Risk Premium. As the ERP gets larger, stocks are considered cheaper relative to bonds.

Since Jan 1999, this factor has done a decent job at predicting stock market returns. Read more here.

Time and Technology

Computers are faster than humans.

Every day, we download Data on 2600+ Stocks and 100+ ETFs. We crunch the data and derive a quick estimate for the performance of each stock and each ETF. This follows the old Cisco mantra: Act quickly and be right 80% of the time.

Long Time Horizon.

The most difficult challenge most people face is how to save enough for a comfortable retirement. We focus our effort on maximizing the accumulation of wealth between now and when clients start to tap retirement funds (typically 65 to 75).

Once our clients have solved that problem with a comfortable margin, our focus shifts to how to maximize your family wealth over multiple generations.

We work with clients to achieve these two long-term goals.

Modern Portfolio Theory

Modern Portfolio Theory optimizes the expected reward for each level of expected risk. It can be performed on long portfolios and short portfolios.

The bulk of our client's assets are in these optimized long and short portfolios.

A small portion of a client’s portfolio is used to capture excess returns using the most significant financial market inefficiencies we can find. Those vary over time.

Fully Exploiting Tax Advantaged Accounts

Taxes on short term capital gains are so high that very few trading strategies are more profitable than buy and hold or sell and hold in taxable accounts. That’s why we work with clients to get as many assets as possible into tax advantaged accounts. Here are some examples:

Coverdell ESAs and 529 plans
Healthcare Savings Plans
Traditional and Roth IRAs
Employer 401K, 403B, 457 Plans

Employer Perks and Tax Breaks

Employer Perks

We help our clients take advantage of employee stock purchase plans, matching contributions for retirement accounts, defined benefit plans, and deferred compensation plans.

Tax Breaks

We help our clients utilize tax breaks like cost basis adjustment on the death of a spouse, deduction of investment interest expenses, and deduction of management fees.

If you have any questions or would like to learn more about our investment philosophy, please contact us.