March 10, 2022 - Commentary 

Key Commentary Headlines:

• *Increased market volatility has provided an opportunity to harvest profits in our S&P 500 hedges here in March and re-invest those funds in stocks trading at significant new lows
• *In February, the market rotation continued to favor value over growth
• *Our Large Cap stock portfolio out-performed and our mid- and small-cap stocks were under-performers for the month
• *Earnings season was strong again as our portfolio stocks delivered material revenue surprises, EPS beats, and positive forward guidance

Market backdrop in February

The markets saw an increase in volatility in late February and March driven primarily by the conflict in Ukraine. As a hedged equity strategy, increases in volatility (aka ‘the VIX’) drives the value of our hedges up and also the general cost to be hedged. Volatility is more commonly associated with market declines and February saw the selloff pick up steam in large cap stocks while it took a brief pause in the small- and mid-cap stocks. Remember that the small- and mid-cap stocks experienced a materially worse January than the large caps so some of this performance divergence in February is a likely reversion to the mean.

Within the large cap realm, the growth stocks led the way down for the index as the S&P 500 growth vs S&P 500 value indexes delivered -4.5% and -1.4%, respectively, in February. As a point of comparison, the Nasdaq 100 was down -4.5% for the month which is mostly large cap growth stocks with significant representation in the S&P 500 and S&P 500 growth index. The S&P 500 finished down -3% for the month.

The Russell 2000 was up +1% while the S&P 400 Mid Cap index was also up +1%. These two indices represent a good proxy for performance in the small- and mid-cap space, respectively. While both finished up +1% and both saw value outperform growth within their index, the divergence between growth and value was a little different. The Mid-cap growth to value divergence was only 30 bps (0.97% to 1.26%, respectively) and the divergence in the Russell 2000 was over 1% as the growth to value returns were +0.44% to +1.65%, respectively.

Our Portfolio in February

We were a material outperformer in our Large Cap portfolio – especially when one considers the growth we held. Picking its stocks primarily from the S&P 500, our Large Cap equity portfolio delivered -0.8% returns in February which is solid given the -3% returns of the S&P 500. These returns are even better considering the -4.5% returns of the S&P 500 growth index in February. Our S&P 500 hedges offered modest return benefits and the result was a material outperformance for the Large Cap Hedged Equity portfolio.

Our Mid-Small-cap equity portion of the portfolio was a laggard for the month as it was down around -1.5% when the Russell 2000 was up +1%. Our Russell 2000 hedges were a modest drag on the portfolio (-20 bps) for the month as the Russell 2000 was up +1%.

The All Cap portfolio is the combination of the Large Cap and the Mid-Small cap portfolio with a Russell 2000 hedge. As you’d expect, it delivered returns better than the S&P 500 / Russell 3000 but not as strong as the Russell 2000. Given our material exposure to the mid-small cap universe, we’d prefer to see returns closer to the Russell 2000 outcomes. However, given the lag that Growth continues to represent in the markets, and the increased market uncertainty, we are not disappointed. 

So far in March

The market sell off has picked up some steam in March thru yesterday (March 10^th) as the conflict in Ukraine continues to create significant uncertainty. With uncertainty, investors are reducing risk exposure. The S&P 500 finally reached a level where our hedges moved into the money in both the Large Cap Hedged Equity strategy and in our ETF (ticker: SENT). We harvested the profits from our S&P 500 hedges and rolled the protection levels down to new lower strikes that are out-of-the-money. Using the profits, we were able to purchase more stocks at significant discounts to end of 2021 prices.

Taking profits in hedges and buying stocks with those profits is a key component of a well-run, disciplined hedging program – and it is also the secret sauce to the long-term outperformance of a hedged equity strategy. We are not calling a bottom in the markets when we take the profits and roll down the hedges. Instead, it is a commitment to re-balancing the portfolio. During a material market selloff, the hedges have appreciated and the equities have depreciated. We are selling down the appreciated assets and re-investing in the depreciated assets. If markets keep selling off, we will be forced to do it again. Back in 2020 during the Covid selloff, we took profits in hedges twice.

Not only do we get to purchase stocks at new low prices but we can emerge in the recovery with more shares than we started with. This provides us with ‘leverage’ to ride the appreciation of the market back upwards with more shares – without using any actual margin or account leverage. 

The hedges in the Russell 2000 already took profits earlier in the year and were rolled down. As markets went up, we reset those Russell 200 hedges higher and now those hedges stand only around 4% out-of-the-money (at close yesterday March 10^th) which will provide solid protection in the event the market rolls over and heads sharply lower.

Earnings season results

The earnings season is mostly complete as we have had only ten portfolio companies announce in the last two weeks, after having averaged over fifteen stocks per week in the preceding four weeks. Our metrics continue to be strong. We had 95% of our portfolio companies beat or meet on Revenue expectations. We had 87% of our portfolio companies meet or beat on EPS expectations. We also had 32 companies provide upward guidance with only 10 providing downward guidance (and 6 companies provided mixed guidance). All of these metrics are consistent with the strength we have shown in the last 4+ years of finding companies that can beat Wall Street’s EPS & Revenue expectations. In fact, this quarter’s EPS and Revenue outcomes are materially higher than the average beat/meet rate achieved by S&P 500 companies in the quarter.

You can see our stock-by-stock earnings report here at this link:  Click here

2022 Year to date comparison to Hedged Equity Leaders

Our one-year performance has now dropped below our peers for the first time since our launch of these hedged equity strategies. However, the 2-year performance is still well above our peer competitor’s fund returns. In fact, our 3-year and 4-year returns enjoy an even wider spread when compared to our peers. Given the material exposure to small- & mid-caps and the negative returns of small cap over the past year, we believe the portfolios have performed admirably. Reach out to us and we’ll share with you the analysis. These hedged equity mutual funds are the largest Hedged Equity mutual funds by Assets under management according to Morningstar.

Source: Morningstar

Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the most recent standardized performance for the funds, click on the following respective ticker: JHQAX; GATEX; SDRAX; GTSOX; CAHEX.

These funds were chosen for comparison because they are some of the largest publicly traded funds employing a hedged equity strategy and have at least a five-year track record. We figured, let's compare ourselves to the BIGGEST players in the industry.

PERFORMANCE  as of 2/28/2022

For all returns covering more than 12 months, the returns are annualized. For the Alpha DNA Large Cap Hedged Equity, the inception date is 3/1/2017. For the Alpha DNA Mid-Small Cap Hedged Equity, the inception date is 1/1/2018.

You can find a summary of our returns below. Please reach out to talk to us about these exciting cutting-edge strategies at (443)-288-6444. Or email us at wayne.ferbert@alphadnaim.com

Disclosures:

Note: Returns are expressed in US Dollars net of fees.

Alpha DNA Investment Management is a registered investment adviser and investment manager that specializes in quant equity strategies. Alpha DNA is a separate accounts manager and all returns expressed herein are solely from the separate accounts business within Alpha DNA. 

ALPHA DNA ALL CAP HEDGED EQUITY Composite includes all institutional and retail portfolios that invest in a diversified portfolio of over 50 total U.S. equity positions – either long and/or short. The strategy aims to reduce systematic market risk by identifying the stocks most likely to out-perform other stocks based on changing demand. Risk is further mitigated by implementation in market neutral posture when the research indicates potential for a downward market. The portfolio is designed to find picks that will out-perform the counter-parts. The Internet Advantage Strategies is a series of strategies based on an innovative new research approach; ALPHA tracks the digital Internet footprint of publicly traded companies to find hidden demand trends in the market place. This composite includes all portfolios that were at least 70% dedicated to this strategy.   The benchmark is the HFRI Quantitative Directional Equity Hedge Fund Index. The HFRI Quantitative Directional Equity Hedge Fund Index is a subset of the HFRI Equity Hedge Fund Index that measures the aggregate performance of equity hedge funds that employ quantitative strategies that can use long and short equity positions and the portfolio can be positioned net long or net short. HFRI benchmark will always include an estimate from HFRI for the most recent month. The returns are typically finalized by HFRI within one month after the end of the reported month – but can sometimes be revised up to 90 days later by HFRI.

Alpha DNA claims compliance with the Global Investment Performance Standards (GIPS). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.  To receive a full list of composite descriptions of Alpha DNA and/or a presentation that complies with the GIPS standards, contact Wayne Ferbert at (443)-288-6444 or wayne.ferbert@alphadnaim.com

All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is no guarantee of future results and there can be no assurance, and clients should not assume, that future performance of any of the model portfolios will be comparable to past performance. 

These results should not be viewed as indicative of the advisor’s skill. The prior performance figures indicated herein represent portfolio performance for only a short time period, and may not be indicative of the returns or volatility each portfolio will generate over a long time period. The performance presented should also be viewed in the context of the broad market and general economic conditions prevailing during the periods covered by the performance information. The actual results for the comparable periods would also have varied from the presented results based upon the timing of contributions and withdrawals from individual client accounts. The performance figures contained herein should be viewed in the context of the various risk/return profiles and asset allocation methodologies utilized by the asset allocation strategists in developing their model portfolios, and should be accompanied or preceded by the model.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility.