For David Wright and Kenneth Sleeper, co-founders and managers of Santa Monica, California-based Sierra Investment Management’s Sierra Core Retirement Fund, understanding the nature of the risks inherent in every asset class is far more important to proper portfolio management than trying to opportunistically grab the possible returns they offer. Different asset classes behave in different ways at different times, and the duo–who have been managing money in separate accounts for close to 23 years and launched the Core Fund in 2007–spends two- thirds of their analytical time studying risk just so that they can understand these peculiarities. They look to measure how a particular asset class has reacted over time to different market conditions and how it will perform, in light of this, going forward. They follow this diligent risk management practice, Wright says, so that they can come up with their own proprietary disciplines that will then enable them to meet their dual goal of limiting the downside on the $370 million Core Fund by exiting problem areas before they sink, and delivering realistic, consistent returns to investors by taking advantage of any sustained upward movement in a given asset class.
“We have a very goal-oriented approach and these are the two very specific goals that we express to our clients,” Wright says. “Everything that we do at Sierra has to serve one or both goals. Even in a very ugly month or quarter, we want to limit the downside of the portfolio to 4% or 5% and our goal is to average 8% or 10% over a market cycle.”
Giving great importance to the understanding of individual asset class risk has enabled Sierra–both in its separate accounts as well as in the Core Fund–to avoid some of the worst disasters in financial market history, Wright says. He believes the cornerstone of Sierra’s risk management practice is the “trailing stop” discipline that the firm applies to each underlying fund within the fund-of-funds Core Fund portfolio, one that is based upon Wright and Sleeper’s in-depth study of economic cycles, the behavior of individual asset classes in different market conditions and the historic volatility of each asset class. The trailing stop discipline allows the Core Fund to limit the impact of any sustained decline in a given asset class or fund to the portfolio as a whole. Rather than attempt to buy at lows and sell at highs, Wright says, the trailing stop approach enables Sierra to participate in any sustained uptrend that an asset class offers and to also step aside during most of any sustained downward trend. Yet this investment approach is tactical rather than active, Wright says, meaning that “we expect to be out of a given asset class on average only twice a year.”
Over the years, the trailing stop strategy has been extremely successful, both for Sierra’s separate accounts as well as for the Core Fund, which year-to-date, is up more then 3% and has been, since its inception, the top performer out of around 325 funds in its Morningstar peer category. Sierra has also averaged returns of slightly over 10% in all its vehicles over the past 15 years, Wright says, thereby meeting its second goal on a consistent basis.
The Core Fund is designed to meet the needs of more conservative investors such as retirees and boomers approaching retirement, and it invests in a broad range of asset classes–domestic and international equities; high yield and investment grade corporate bonds; foreign exchange and government debt, to name a few–through leading mutual funds (open-ended as well as ETFs) whose managers have outperformed their peers consistently over time.
Currently, Wright says that the Core Fund’s more risky holdings–high yield bond funds, emerging market debt funds and floating income funds–are giving off sell signals. He attributes this to another wave of market downturn, one that despite the general market exuberance of earlier this year, is imminent and, in fact, has already begun. This is the third phase of the downturn that began two years ago and it will result, as all other downturns have, to a general flight to quality, Wright says. Sierra’s trailing stops enabled the firm to see this trend early, and Wright was able to exit the Fund’s riskier holdings before those asset classes started trending down.
Now, with a view to more volatility in riskier asset classes and further downturns across the market, the Core Fund has 52.7% of its holdings in cash. It has 11.5% of assets under management invested in the Putnam Diversified Income Y fund; 11.1% in PIMCO’s Foreign Bond Institutional fund; 9.4% in the Nuveen High Yield Municipal Bond R fund and 5.6% in the Managers Bond Fund.