Buybacks slowingCEO confidence remains high pg. 7

Outsourcing for productivity pg. 3

Identifying realistic estimates of strategy performance pg. 4

4 bases to cover inretirement planning

Richard D’Ambola

pg. 8

July 31, 2014 | Volume 3 | Issue 5First magazine focused on active investment management

advisor webinars that are helpful in fully understanding the nuances of a particular strategy.

The biggest benefit is more psychological and less tangible. I know that the active managers I choose for client portfolios are working 24/7 to monitor the per-formance of their strategies and the market environment.

Knowing that my clients’ assets are actively managed every single day—going short, going long or even going into cash—frees up my time to focus on prospecting and on client retention needs.”

side from my own client base covering

several states, I am ultimately re-sponsible as a branch manager for the work of multiple financial advi-sors across a wide geography—my schedule can get very hectic.

We gain a lot of efficiencies in our practice through our use of third-party managers.

Our broker/dealer, Transamerica Financial Advisors, Inc., does a ter-rific job of due diligence regarding third-party investment managers and provides a range of different options. While I obviously need to select managers appropriate to client needs and objectives, that basic legwork is done for us and done well.

Since 2005, I have been increas-ing the use of third-party managers in my practice. They have well-con-structed risk profile assessments that are user-friendly and facili-tate matching client money with the appropriate strategies. Their reporting formats are an excellent tool with clients, as are materials helping to explain the role of active management. They also conduct

Outsourcing to increase productivity

Steve MillerAlpharetta, GA

Transamerica Financial Advisors, Inc.CEO, Steven A. Miller, Inc.

A“Read text only

Last week’s results

What is most important to you in selecting investment strategies/products?

-Vote to see results

This week’s poll

Approximately how much of your time is spent on administrative/regulatory compliance tasks?

Global Results

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81%

43% 29% 29%

79% 82%

Managing risk

Managing volatility

Producing income

POLLS

VOTE

10%

20%

30%

40% or more

Steve Miller is a Registered Representative and an Investment Advisor Representative with Transamerica Financial Advisors, Inc.

Securities and Investment Advisory Services offered through Transamerica Financial Advisors, Inc. (TFA), Transamerica Financial Group Division—Member FINRA, SIPC, and Registered Investment Advisor. Non-securities products and services are not offered through TFA.

July 31, 2014 | proactiveadvisormagazine.com 3

TIPS & TOOLS

“Past performance is no guarantee

of future results.” We see this statement everywhere finan-

cial performance is advertised. No one ex-pects the future to be exactly like the past, but isn’t it reasonable to expect them to be similar? After all, history may not repeat itself exactly, but to paraphrase Mark Twain, it often “rhymes.” Wouldn’t it be nice to know if the past performance of a specific strategy has a good chance of continuing?

Answering this question effectively is one of the key reasons my partners and I formed our company. In brief, we work with third-party asset managers to estimate the chances an active investment strategy will continue to perform as it has in the past. Using statistically sound methods, we perform a high level of due diligence on active strategies.

So why should a financial advisor care? Because clients count on advisors to provide realistic estimates of future performance

despite the ubiquitous “past performance” warning. But how can we do that? Since the past is not completely reliable, how can we generate realistic expectations for the future?

Before discussing the answer to that question, we need to understand why, in

By Dave Walton

Whenhistoryrhymes

“... history may not repeat itself exactly, but to paraphrase Mark Twain, it often ‘rhymes. ’ ”

Identifying realistic estimates of future investment strategy performance

proactiveadvisormagazine.com | July 31, 20144

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some cases, future investment strategy per-formance can be radically different from the past, even when the market conditions seem historically similar. One major culprit is the Data Mining Bias (DMB).

Haven’t heard of the Data Mining Bias? You’re not alone. Despite the impact it can have on future investment strat-egy performance, DMB remains rela-tively unknown, misunderstood, and in some cases, outright ignored. DMB is sometimes referred to by other names,

including curve-fitting, over-fitting, data-snooping, or over-optimization. Regardless of what we call it, the presence of DMB can fool an asset manager into be-lieving a worthless investment strategy has the ability to produce excellent returns.

We can understand how DMB happens using a popular metaphor. Imagine we give a billion monkeys computer keyboards, provide them rewards for typing, and let them bang away for days, weeks, months, even years. Given enough time, eventually one of them will produce a line or two of Shakespearean prose. Does that mean the monkey who quoted Shakespeare is a true thespian and is likely to continue creating literary master-pieces in the future? Of course not.

The Shakespearian monkey example shows that given enough time and resourc-es, it is not only possible, but highly likely that luck will impersonate mastery. Yet, the exact same “luck” effect is present in many human-created investment strategies, but is less easily recognized. Why? Because there are thousands of people creating investment strategies using resources (computing power that was unimaginable 25 years ago) who in aggregate try millions—even billions—of strategy combinations and pick only the best ones to trade through a process called optimization. Using this type of selection process to build investment strategies is ex-actly the same kind of process that allowed our monkey friends to create prose from random key banging.

All historical investment strategy results are a combination of both a market edge and luck, although the balance between the two varies considerably from strategy to strat-egy. But how can we tell the difference? In a moment, we’ll discuss a method, called System Parameter Permutation (SPP), de-signed to help identify the real “edge” in a

given investment strategy.But first, let’s discuss another issue

with how investment strategy results are typically described. Performance results are usually presented like this: 14% annual return with a maximum drawdown of 20% over the last ten years. So what’s the problem? These single numbers for return and drawdown—also known as “point” estimates—mask the variability we are likely to see while running the strategy. So, if the strategy returns only 2% one year, is the strategy broken? These so-called point estimates don’t provide much help in answering that question.

Wouldn’t it be much more useful to un-derstand the range of likely outcomes? How about the probability of achieving a certain annual return? Armed with this additional information, advisors can make more in-formed decisions about the suitability of a given strategy for a client and maybe avoid a few panicked phone calls.

Is there a better way? In my opinion, there is. To arm asset managers with a simple, yet powerful, way to address these issues, I de-veloped a technique called System Parameter Permutation (SPP). SPP has been well re-ceived, and in May 2014, I was presented the National Association of Active Investment Managers’ prestigious Wagner Award for a paper describing the method.

SPP offers a practical way of measuring the range of expected system performance, rather than providing a potentially mislead-ing “point” estimate. And remember the op-timization processes those investment asset managers used to create a huge number of strategy combinations? The beauty of SPP is that it leverages that optimization data to cut through the DMB and help identify the real investment strategy “edge.”

continue on pg. 11

Data Mining Bias can fool an asset manager into believing a worthless investment strategy has the ability to produce excellent returns.

Wouldn’t it be much more useful to understand the range of likely outcomes? How about the probability of achieving a certain annual return?

Identifying realistic estimates of future investment strategy performance

July 31, 2014 | proactiveadvisormagazine.com 5

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Buybacks slowing while CEO confidence remains high

ith another generally positive earnings season in the process of winding down, the lackluster broad economic

picture in the U.S. does not appear to be significantly affecting those results or the optimism of major company CEOs. Over 50% of U.S. companies have reported for Q2, with 64% surpassing estimates on earnings and 62% exceeding revenue estimates (as of 7/25).

Despite the Conference Board’s measure of CEO Confidence ticking slightly downward during Q2, a positive outlook remains. CEOs were upbeat regarding continued profitability—primarily as a result of higher market demand for goods and services. Such confidence in the business community bodes well for capital spending and employment prospects, says InvesTech Research.

Although earnings and the CEO confidence measure are positive indicators going forward, a recent MarketWatch analysis points to the less encouraging downturn in corporate stock buybacks. Strong levels of corporate stock buybacks through 2013 and early 2014—fueled by

WSource: InvesTech Research

the low interest rate environment—have helped drive equities to new all-time highs.

New stock buybacks fell to $23.2 billion in June, the lowest level in a year and a half, according to fund tracker TrimTabs Investment Research. In May, the total was just $24.8 billion (versus a monthly

average of $56 billion in 2013). That’s worrisome, says TrimTabs CEO David Santschi, because “buyback volume has a high positive correlation with stock prices.” While the buyback data can be volatile, MarketWatch concludes that it is a trend worth watching.

TOPPING THE CHARTS

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CEO CONFIDENCE

DRAMATIC SLOWDOWN IN BUYBACKSMonthly total of new buyback announcements (in $ billions)

RECESSIONS

POSITIVE OUTLOOK

FEAR OF FISCAL CLIFF

FEAR OF DEBT CEILING SHOWDOWN

July 31, 2014 | proactiveadvisormagazine.com 7

4 bases to cover inretirement planning

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Richard D’Ambola

By David Wismer

8 proactiveadvisormagazine.com | July 31, 2014

Proactive Advisor Magazine: What concerns are you seeing from clients and prospects, Rich?

Rich D’Ambola: While there is a lot of hype, marketing, and seminars by our industry regarding the retirement crisis, unfortunately a lot of it is very real.

Our practice tends to center around pre-re-tirees or those already in retirement and there is a terrific need for client education on several issues. There are four core areas people may not really understand that we talk about: longevity, taxes, healthcare, and inflation.

In terms of longevity, it is a matter of those in retirement not outliving their assets and other related income streams. Medical technology is amazing and it is estimated that well over 50% of the population will outlive government-es-timated life expectancies. Watch Willard Scott in the morning and you will be amazed by the number of people celebrating their 100th birth-day. A good financial plan has to take longevity into account for both husband and wife.

Taxes are a big unknown and also require contingency planning. We are at one of the lowest points in history in terms of tax brackets. Is that going to continue? How might increases affect retirees? And related to that is all of the un-certainty hovering around Social Security fund-ing for the long term—will that in some way impact people retiring over the next 10-20 years?

Healthcare costs are also a matter of great concern for retirees. There are all of the changes moving through the system and each individu-al’s health is so unpredictable.

Adding to all of these matters is the outlook for inflation. What will the interest rate and in-flation environment over the next twenty years be like? Simple mean reversion says both have to go up.

So, yes, there are plenty of anxieties out there and they are very real.

What types of solutions do you provide?

We strive to bring real value into people’s lives as far as developing financial plans and in-vestment strategies that can make a difference. We want to take a macro view of their needs and find solutions to grow their assets and income in retirement. This includes, for many people, introducing them to risk management princi-ples and active investment management, which they likely have not been exposed to before.

How do you introduce the topic of risk management?

We have come to the belief that sequential return risk has to be a top priority for anyone planning for retirement. It is the hard trade-off be-tween needing asset growth over time to fund your retirement and the unwillingness to expose portfo-lios to the large risks that can decimate a portfolio.

We have seen with new clients that come through the door how bad an impact the credit crisis had on their retirement portfolios. They are facing difficulties in even getting back to where they were. Sure, the markets may have recovered, but that does not help someone who may have had to draw down their already underwater assets during the past five years. So that is what we mean by sequential return risk—it can all be in the timing of how markets are performing at any particular point in time relative to your personal situation.

How do you overcome that?

First, we explain to clients about market cycles. Most everyone is aware of market crash-es and the big bull market periods, but few really understand market cycles. Sixty percent of the time markets are heading higher, 20% of the time they are in bear markets, and 20% of the time they are going sideways.

So if you really look at that, history tells us that 40% of the time markets are in unfavorable conditions. How are you going to manage that? Does it make sense to take a passive approach? We think not.

That is why we employ third-party active man-agers who have sophisticated models and methods of portfolio allocation. They are not bound to sit idly by and watch a severe market downturn.

I tell clients it is like having a highly ad-vanced Doppler radar early-warning system. These managers have the technology to know a Category 5 hurricane might be coming. And just like with a hurricane forecast, they may not always be right in predicting the actual occur-rence or the severity of it if it does hit. But their systems have been designed to make the funda-mentally correct call on the markets. Wouldn’t you rather have that knowledge working on your side and have the chance to make prepara-tions for a storm?

continue on pg. 10

For many investors, planning for retirement can feel like

a swing and a miss. Rich D’Ambola approaches four challenges

to retirement planning—helping his clients hit home runs.

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July 31, 2014 | proactiveadvisormagazine.com 9

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are able to incorporate alternative investments to build in more portfolio diversification, taking advantage of less correlated asset classes. This is all part of the risk management element of what they do and there is a role for every tool that they use at one time or another.

One of the active strategies we like in par-ticular has the ability to incorporate lever-age during strong bull markets and to short the market during downtrends. Going back to my weather analogy, it is akin to changing your clothes to fit the season, whether that is employing short-term tactical tools or placing greater or lesser emphasis on a particular asset class or strategy as conditions dictate. Doesn’t that make pretty good common sense?

Great explanation, Rich.

I am there to serve clients with what we think are the very best fiscal solutions. My job is to look at things at all levels and uncover, identi-fy and solve problems. Risk management is a big piece of my job description—as is making sure clients have an understanding of the importance of its role within their investment portfolios.

Do clients understand active management?

A very helpful piece in explaining the active management story is showing them the math on market losses. Few people realize that if they take a 40% loss in their portfolio, it takes far more than a 40% gain to make it back.

There is another aspect that is terribly im-portant to clients: after the dot-com bust and 2008, many are fearful of the stock market. By explaining the risk management and asset protec-tion elements of active management, we can help many of those people be more comfortable with utilizing equity investing. That’s where history can work in our favor, as compounding market returns over time is critical to building wealth.

Is this the case only for equity investments?

No, that is another benefit of using our third-party active managers. It is not plain va-nilla equity or bond mutual fund portfolio con-struction. Active management can be used with both types of investments. And these managers

continued from pg. 9

Securities offered through Questar Capital Corporation (QCC), Member FINRA, SIPC. Advisory Services offered through Questar Asset Management (QAM), a Registered Investment Advisor. Dunn’s Financial Review is independent of QCC and QAM.

10 proactiveadvisormagazine.com | July, 31, 2014

There can be no assurance that any investment product will achieve its investment objective(s). There are risks associated with investing, including the entire loss of principal invested. Investing involves market risk. The investment return and principal value of any investment product will fluctuate with changes in market conditions. Guggenheim Investments represents the investment management businesses of Gug-genheim Partners, LLC. Securities offered through Guggenheim Funds Distributors, LLC. Guggenheim Funds Distributors, LLC is affiliated with Guggenheim Partners, LLC. x0515 #12526

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As shown in the figure, SPP takes all of the optimization data used to build an in-vestment strategy and shows where the “point” estimate (which is what most invest-ment asset managers provide) falls within the range of likely performance. Relatively

easy-to-apply statistical techniques can be used to evaluate the likelihood of achieving a specific performance target, and the chance performance will fall within a given range (e.g., a 90% chance of an annual return be-tween -1% and 11%).

In brief, the SPP process involves the following steps:• A range of investment strategy parameters

and an evaluation time period are selected.• All combinations of the selected parame-

ters are simulated individually (as would be done in exhaustive optimization) using a realistic, portfolio-based backtest engine.

• The results of each simulation are com-bined to create a range of values for each performance metric of interest. In the figure, we used Compound Annual

Return (CAR) as the metric of interest, but SPP allows us to estimate similar ranges of performance for other metrics including the maximum drawdown, Sharpe Ratio, etc.

In summary, clients rely on advisors to select the most suitable active strategies, but suitabil-ity requires an understanding of strategy reli-ability and realistic ranges for future system per-formance. SPP provides a simple method asset managers can use to determine both. In turn, this helps advisors utilizing third-party strate-gies to have greater confidence in the strategies used to achieve their clients’ objectives.

continued from pg. 5

View entire white paper

System Parameter Permutation (SPP)Determining the range of likely performance

11July, 31, 2014 | proactiveadvisormagazine.com

The opinions and forecasts expressed herein are those of the author and may not actually come to pass. Any opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. The analysis and information in this edition and on our website is for informational purposes only. No part of the material presented in this edition or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any portfolio constitutes a solicitation to purchase or sell securities or any investment program.

EditorDavid Wismer

Marketing CoordinatorElizabeth Whitley

Contributing WritersDave Walton

David Wismer

Graphic DesignerRoger Ackerman

Contributing PhotographerJennifer Pottheiser

July 31, 2014Volume 3 | Issue 5

Proactive Advisor Magazine is dedicated to promoting and educating on active investment management. Distribution reaches a wide audience of financial professionals who advise clients on investments and portfolio management. Each issue features an experienced investment advisor who offers insights on active money management, client service, and investment approaches. Additionally, Proactive Advisor Magazine offers an up-close look at a topic with current relevance to the field of active management.

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Proactive Advisor MagazineCopyright 2014 © Dynamic Performance Publishing, Inc. All rights reserved. Reproduction of printed form, whole or in part, without permission is prohibited.

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Top 10 retirement challenges todayFinancial planners and thought leaders from the American Institute of CPAs recently identified the top retirement planning and aging issues facing Americans (and their advisors).

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the equity markets.”

Great client questions you should ask yourselfMore than 400 advisors were asked to share the one question that opened the floodgates for clients and got them talking about their lives and their hopes for the future.

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12

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