Wayne Penello

That caught the attention of Forbes Books. And they approached me and I published that methodology in a book called Risk as an Asset that's available on Amazon. I don't own the rights to it anymore because shortly thereafter, I sold the company to one of my competitors and they wanted everything. And I was actually very glad to have them because I've been doing this for a long time and took the winnings from selling my business and looked around at the equity space and said, OK, who am I going to get help me manage this while I go into retirement? Well, I couldn't find anybody I trusted. And the main reason was that in equities, they don't manage risk.

They diversify it away. And the problem with diversifying it away is it means some portion of your capital is getting equity style returns, let's say 10%, 12% a year. And you're taking risks to do that. And the other part of your portfolio is getting bond type returns, which back four years ago was nothing. Today, it's 4%, but it's still nothing. And I said, there must be a better way. So I spent the last four years working on a methodology that would allow me to create a portfolio that one, managed risk without sacrificing returns. And then two, made it available to the average investor. You didn't need to be a qualified investor.

But technology has changed in the 70 years since they did that work. And I took it upon myself to take a deep, dark look into it. And what I found is that the market predictability on an individual level, and I would agree with Fama, nobody knows what's going to happen tomorrow. Nobody knows really what's going to go up or down. So what we took the approach is that we wanted to use pieces of the equity space as a hedge since all of the various different industry sectors are reasonably well correlated. That is, typically 70% or higher.

And we said, can we find a way to use the industry sectors themselves as a way to hedge the systemic risk? That is, when it's a risk-off trade and everybody is selling everything, how can we risk that? And so the idea was actually born out of an observation made by a fellow whose name is Charles Ellis. He chaired the Yale Endowment Fund for a number of years. He wrote a book called Winning the Loser's Game. And on page 25 of his book, he points out that if you bought and held the S&P 500, your dollar over a 10-year period would grow to about $5.59. But if you missed the best 90 days, think about that.

There's roughly 2,500 days in 10 years. But if you missed the best 90 days, your dollar would shrink by $0.22 to $0.78. And so he made that as a very strong argument, which the whole world is still embracing, that buy and hold is the only way to go because you can never predict which of those are going to be the 90 days. But then he went on to say, to me, the most astounding thing, if you miss the worst 90 days, your dollar would grow to $43. Think about that. Think about how punitive those worst 90 days are. And so I looked at this and I said, he's identified the low-hanging fruit.

We're not going to try to be smarter than the market. We're just going to try to be less stupid than the market. And there's no way we're going to figure out which days are the bad days. But if you think of the S&P 500 as a horse race and think about which industry sectors are going to be in the back half of the pack, the nags of the market, if you will, maybe we can do something with that. And so I did what I call a crystal ball analysis. I said to myself, let's just take oil and gas, for example, XOP. If I knew next month that XOP was going to outperform the S&P 500 or the other way around, and I got to with the crystal ball, if I knew that, so I always own the one that performed better, whether or not it made or lost money.

But I always performed the better of the two assets. Well, if you bought and held the XOP, the period under this study was 13 to 2023, you would have had a compounded loss of 2.5%. But if you had the crystal ball, you would have made 63%. Think about that. 63%. So I invented what I call a foggy ball. It's not perfect. It's statistically driven. It uses momentum indicators, and it uses what I call edge of the envelope indicators. So you just think of Elliott Wave analysis. And I use many of them because I want to cover many timeframes.

Well, when I use my crystal ball and I do what the algorithm says, I raise returns from a negative 2.5% to about 24%. So I capture roughly a third of the opportunity. It's not perfect, but it works. And when we couple that with a portfolio of 16 ETS where the foggy ball works reasonably well, and we balance that portfolio so that we get a risk-reward structure that we're comfortable with, we're basically targeting a sharp ratio in excess of 2 and returns that beat the S&P 500. We weren't trying to maximize returns. We're just trying to find that great balance that, I don't ever want to experience a 10% drawdown.

And from a model perspective, we've achieved that. As we go through life and we see what happens in the real world, we'll find out. My models are models, right? They're not the real world. But we launched in December, and so far, so good. Yeah.

Do you generally find those 90, best 90, worst 90, highly correlated in the same areas, just trying to miss the bombs? Or do you find that they're very hard to predict and can come out of nowhere?

And then all of a sudden computers were available to analyze this huge volume of data. And so, Markowitz, Schaub and Farmer, they were the first guys to ever look there. Farmer himself said, it didn't matter what we did. Anything we did was new because nobody had ever had the opportunity to do it before. That's great.

Right now we're using 16 different ETFs in our portfolio. And now what we're looking for is, some of them duplicating the work, like are they remarkably the same? So having two is the same as having twice the allocation to the one. And so we, one, have to identify a portfolio of ETFs that are suitable candidates. Then we take that portfolio and we take that group of ETFs that are suitable and we start to create through an iterative process portfolios that we believe are going to work. And then we fine tune that. So finally we get, we started with the one we have now, Efficient Market Portfolio Plus, EMPB, because it appeals, in my mind, it appeals to new investors.

Those are just starting out and, really don't want to take a big hit, even though they have another 40 years of earning power ahead of them. And those at or near retirement who absolutely do not want to suffer a setback because they have no earning power going forward. So we have portfolios that are on the drawing board that are themed and they perform as well. And we have long only that perform as well, but they all have slightly higher risk components. And I think they'll be attractive to investors at some point in the future, because no matter how you tell people that don't try to time the market, everybody tries to time the market. And I can envision a world where there will be a bunch of people that say, OK, I think the market's going back up now.

So I'm going to go in the long only portfolio. Oh, no, I'm a little bit nervous. I'm going to go back to the long short portfolio. And God bless them. I know they're both going to work well. It's just a matter how much risk you want.

But in reality, it's a way to kind of dampen overall volatility compared to just diversification alone. So how does EMPB use short positions to actively manage systematic risk rather than try to diversify? Diversify its way out of it.

And it's it's it's had about as many losing days as it's had winning days. And those winning days, those losing days are actually because we're down, obviously larger than the winning day. So if we look at the winning days, there's the S&P made approximately a cumulative gain of 40 percent. If you summed up the gains on all the winning days. And if you look at us, because we're long short, we only generated 24 percent. So on the on the long days, the S&P beat us by 14 percent or 16 basis points, 16 percent. But but we're still capturing about two thirds of that gain.

But the winner here, and this is why you want to have shorts in your portfolio. When you look at the losing days for the S&P, it lost a cumulative 54 percent. We only lost 22. So we did not suffer 32 percent of losses that people that own the S&P 500 suffered. And so it's not that we're making more money, it's that we're losing less money. And by losing less money, we have a much more stable product. So it's it's not you're sleeping at night. You're not worried about losing 50 percent of your money. It's and we just discovered that by focusing on industry sectors and, building an algorithm that works, that the algorithm is actually pretty good at figuring out which are the nags of the market.

And and and I will tell you, in the years we were beta testing this thing, there were many times the old, fundamental analyst in the back of my head stepped in or or some news item swayed me. And we would deviate away from the guidance of the algorithm. And in every case, we paid the price. And after about 10 in a row losses of making that mistake, we don't do that anymore. If the algorithm says this is what we're supposed to do, that's what we do. So it's it's another reason for these shorts, too. obviously, if you're long 100 percent AUM and then you're short 50 percent AUM of highly correlated things, the product is going to be more stable.

But what that that does in a long in a net long fund like ours, now all of a sudden people that have IRA accounts can own this because the fund is net long. They couldn't otherwise have the shorts in their account. Those shorts as an ETF generate funds that sit in our account. So if you if you if you look at our website, you'll see that we're long 100 percent of AUM. We're short 50 percent of AUM. And then it looks like we're 50 percent cash. Well, that's the money from the shorts. We're currently earning over 4 percent interest on that, which goes directly to investors. And so now all of a sudden we're getting paid for holding those shorts. So and the 50 percent ratio, while the sweet spot is really between 40 and 60 percent, the 50 percent ratio is important because the collateral of the long position collateralizes the short position.

So unless there's a negative mark to market on the shorts, there is no margin expense. It's just a tremendous opportunity to take advantage of and of the rules of the game. And I should point out that. If we have a 50 percent hedge, it's perfectly hedge. Then if the market falls by 50 percent from 100 to 50 dollars, it has to rally 100 percent to get back to 100. And then we have a perfect hedge. So it falls from 100 dollars half as much to 75 dollars. And then it rallies half of 100 percent. It's going to rally to one hundred and twelve dollars and 50 cents. So all of a sudden we're beating after one cycle, we're beating the spy by 12 and a half percent.

The only the only way that formula gets to break even is if the underlying rallies by 200 percent. And we know that almost never happens. And so with a long, short program, if we can go through multiple cycles where we at least have a very high level confidence that on average we're going to have a 50 percent hedge. All we have to do is go through three or four cycles and we're going to be way ahead of the spy. That's just the way it is. And these cycles aren't just cycles over months. They're, they're within the week. They're day to day cycles. And it's actually quite remarkable how efficient. And it's simply the math.

And. And if you look at some of these regional brokerage houses, they they don't really serve these people very well, in my opinion. I won't mention any specific names, but I just thought that we have open source platforms like, Charles Schwab and Fidelity and Interactive Brokers and a lot of the new up and coming ones. I'm not familiar with all of that. anybody with 100 bucks can get a stock account. Well, now we've got 100 bucks. Now can you get a stock account? But but you can have a seasoned professional that is run whose design developed and is maintaining a very sophisticated trading strategy at your fingertips.

And and all you need is 25 bucks. And and I just it's it's going to be hard to to sell that to a lot of people. I can tell you I was very disappointed when we go out and we talk to, RIAs that are managing. 500 million or billions of dollars, they won't touch this. Why? Because as soon as their people see that they can do well with this, then why am I paying you a fee? I'll just buy that and forget about it. And it's it's I was a little bit disappointed at the the barriers to entry that we've encumbered. But, we're going to persevere. And and I think the performance ultimately will speak for itself.

And as I mentioned to you earlier, we just had a great review in Seeking Alpha on our product. And very pleased that somebody stepped up to the plate and said, this is a different product. You need to take a look at it.

But you and I have had some conversations that's a little bit misleading. And so can you kind of clarify how some of these offsets can work and what that expense ratio really kind of looks like?

But what they didn't or haven't yet and we're contesting this now. But what they're not letting us report is the net to investors across the total AUM. The interest earned on the short positions is going to equate to about one point seven percent a year. That's a that that all automatically makes almost all of it go away. And yet and we're still making dividends on the long position. So they're making us report the money we lose or pay on the on the short positions. But we're long twice as many and they pay about the same dividends. And so the dividend is not an expense. It's a credit. We think that if you go to Morningstar, they're reporting adjusted fund fees at about one point three five percent.

Which is a number I can live with. But I think we're actually going to in this refiling get that that reportable number under one percent, which is in my mind, higher than the customers are actually going to pay once we get the benefit of these other pieces. But it's you can't. You just got to work within the system. And, fortunately, I and in some ways, I think it's one of the reasons why others don't have more long, short funds because they don't want to have to put out that expense ratio. So I see it as an opportunity to grow my business before people wake up that whatever it looks like, it's the smartest thing you can do because it's the best thing you can do for your investors.

Yeah.

And to make a long story short, she didn't like having on a $200,000 account, did not like having a $3,000 drawdown. And I said, all right, I'm going to this is what we're going to do. Since I think my EMPB is unlikely to have a 10 percent drawdown, we're going to put $30,000 in EMPB. And then we're going to put the other $170,000 in T-bills. She's 75 years old. And if I get this completely wrong and you lose your 10 percent on EMPB, you're going to wind up making something like one and a half percent on your money. You're not going to you're still going to make money. But but if I get it right, you're going to wind up making close to seven percent on your money.

And I said, but you should never you should, with the interest you're earning on the on the treasuries, I don't think you're ever going to see a $3,000 drawdown. And by the way, I'm managing your money. So if we need to stop it, we can stop it. So that's, what I want people to take from this is whatever you're investing in, you have to think about how much money can I lose? Most people start out with how much money can I make? Don't start there. Talk about how much money can I lose and make sure that you never lose more than you're comfortable losing. If you do that, you're off to a good start. Now, if you're like me, when I was starting out, I was busy in my commodity business and every time I stepped into stocks, I said, oh, this will work and I don't want to lose more than that.

And I didn't lose more than that, but I lost that over and over and over and over again. So I finally got tired of hitting my thumb with the hammer and said I have to come up with a better way. And so this is the better mousetrap that I believe I've built. And I hope you all are willing to take a look at it and consider including it in your portfolio. And with this woman I was just talking about, I said, in three to six months, we'll visit it again. And once you get comfortable with it and made some money in it, maybe you want to go up from 15 percent in equities to 25 or 30 percent. But the bottom line is however much money she has in equities, she knows what a risk profile looks like.

And that's that that's where I think I think that's the next generation of investing in equities. once people figure out what I'm doing and it works, they're going to be a lot of lookalikes come along. Some of them will be charlatans, but other people are going to do just as good as I've done. And there'll be a great opportunity for people to invest with more confidence and less risk.

But if you call me and tell me why you called, I'll call you back. Let's blame telemarketers.