Alpha Power Investing Newsletter

March 17, 2011

Changing Times

We have now completed two decades of stock market action which dramatically demonstrate the shifting tides of sector performance and, as a consequence, mutual fund performance over time.

If we take a look at the past eleven years, which takes us back to the very peak of the GBM (Great Bull Market), the winners and the losers in the U.S. equity race are very clear.

Those lucky enough to have had a substantial commitment to a decent small-cap value fund have done the best (Lipper: Small Cap Value), generating a total return of about 180% (median). Indexers who concentrated on the S&P MidCap 400 Index also did well - doubling the return of the average mid-cap mutual fund (Lipper: Mid Cap Objective) 134% vs. 66%.

Even the average mid-cap and small-cap fund (Lipper: Small Cap Broad) trounced the S&P 500 and all the funds benchmarked to it (Lipper: Large-Cap Growth) - that takes in about 90% of all U.S. equity funds. Those investors unfortunate enough to be in the Fidelity Blue Chip Growth Fund are still underwater, dividends reinvested and all.

Now let's back up eleven years and look at the same categories for the eleven years culminating in the peak of the GBM.

It's easy to see how so many investors got tricked into believing that the Fidelity Blue Chip Growth Fund was a great long-term investment. A total return of almost 900% over the previous eleven years is a powerful persuader. During this period, even the average large company growth fund was able to outperform the S&P 500, the average mid-cap and the average small-cap fund. The worst performing sector: small-cap value.

There are many lessons to be drawn from this example. One is that even a ten-year track record is not enough to establish confidence in a repeat performance. Another lesson is that an attitude of contrarianism is generally good - the popular sector or fund is often at a late stage in the beneficial part of its history.

What would be ideal is an investment that maintains a superior return trajectory throughout the shifting tides of long-term cycles. Let me suggest an investment that is benchmarked to the Mid-Cap Power Index.

For new readers, the Mid-Cap Power Index is constructed by linking two indexes: the S&P MidCap 400 Index and the Barclays Capital Intermediate Treasury Bond Index. The rule for linking them is quite simple: hold the S&P MidCap 400 Index November 1 to May 31, then hold the Intermediate Treasury Bond Index from June 1 to October 31. This index captures the superior returns that come from the long-term "skewing" effect that has been present in the U.S. and foreign markets since World War II. This effect, which tends to push long-term positive returns into the six to seven month period beginning in late October, also causes the majority of market losses to be contained in the remaining months. Of course, this is an effect which normally has little influence over returns short-term, but becomes enormous long-term.

So, let's compare the Mid-Cap Power Index to the components of our previous examples:

Over the past eleven years, according to Lipper, the Mid-Cap Power Index, with an average annual return of 13.81% (ending 12/31/2010), ranked in the top 1% of performance based on a fund universe of 724 growth funds operating since 1999. Over five years, it also ranked in the top 1% of 1,858 funds in the growth fund category. (Source: Callan Associates Database)

But what about 1989-1999?

Pretty much the same story. The Mid-Cap Power Index outperformed all categories and even came close to the red-hot Fidelity Blue Chip Growth Fund. Of great importance to remember is that this superior long-term performance came with 40% less market risk each and every year.

What we see in these two examples is consistent over-performance during two eleven year time frames in which the winners and losers reversed themselves. To me, this is strong evidence that the index will continue its winning ways over the next eleven years, which I expect to be a period of high market volatility, resulting in low returns for traditional buy-and-hold strategies.

To investigate our program, which seeks to duplicate the Mid-Cap Power Index net of fees, go to the Programs and Performance section of our website at and click on the Alpha Mid-Cap Power Index Managed Account link.

If you would like to discuss this or any of our investment programs, please call me at 1-877-229-9400.

Jerry Minton, Ph.D.
1-877-229-9400, Ext. 11

Past performance is not a guarantee of future performance.

© 2011 Alpha Investment Management Inc.

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