J. Michael Martin’s goal for his clients, about 80% of whom are retirees or those getting ready to retire, is not to have a negative return, or to handily outstrip inflation, and he does this by making volatility his friend.
His first rule at Financial Advantage, Inc., a fee-based Columbia, Maryland-based firm he founded in 1987, is to “do no harm” in managing clients’ nest eggs. “Retirees have a shorter time horizon and not only are not putting new money in, but taking money out. So it is appropriate to have a very different investment strategy for retirees,” he says.
Thus, Martin strives to harness the risk in overvalued sectors. Financial Advantage uses double inverse-index funds to short market sectors his analysis identifies as most overvalued. These are volatile funds that move double the amount in the opposite direction from the corresponding index. Martin is also a judicious user of inverse-index funds, which, he says, rise when the stock market falls, and can help protect investors against both short- and long-term market declines.
When a stock index falls and the inverse fund rises, pushing its allocation past the target, Financial Advantage trims its position back to the original allocation and takes profits. Conversely, when the index rises and the inverse fund falls, the firm buys more shares to get back on target. “This method cuts the average cost per share for our clients,” Martin says. “Our two inverse funds are up 41% and any day now we are going to take those chips off the table,” he explains.
At press time in early April, the firm had a 5% hedge evenly divided between a 2-1 inverse on the Russell 2000 and a 2-1 inverse on the Nasdaq 100. These inverse funds increased in value by 30.4% in January and February while the S&P 500 fell 9.4%. Thanks to inverse funds, plus an allocation to gold and cash, the firm’s average client portfolio earned 1.8% over the two months, according to the company.
Martin also has a novel way of looking at his most important investment assignment: diversification, using something called “fundamental market drivers” rather than the standard asset boxes everyone else seems to be using. “Most people think about diversification in terms of market cap or style boxes. We got rid of that concept about four or five years ago. I don’t think that is a valid way to diversify.”