The following articles show the evolution of my portfolio management strategy from the start of the virtual Hedge Synergy Fund to 04/24/08.

NOTE: Most of the following ideas no longer apply to how I manage my portfolios. I believe that my creating more and more complex strategies to respond to the market unnecessarily complicated things. Given the tortured processes I developed to deal with the market the following articles just prove the maxim "it is best to keep things simple".

(Articles have been rearranged in chronological order)

RE-BALANCING
7/03/06

When I started the virtual Hedge Synergy Fund on October 1, 2004, I used 160% gross exposure because I wasn't sure how much the margin would drift. I have since found that margin drift is less than I anticipated. On the other hand, the ratio of long to short stocks has been more volatile than I would like. I came to the conclusion that I would have to periodically adjust the long and short stock ratios to bring them back in line. Once I decided to alter my strategy to re-balance the portfolios to bring the ratios back to their initial settings at the beginning of each new quarterly portfolio, I realized that I could use an initial margin that was closer to 50% and thus increase the gross exposure. After analyzing the amount of margin drift over periods of one month and three months, I decided it was possible to increase the gross exposure to 180%.

Therefore from October 1, 2004 to July 3, 2006 the virtual Hedge Synergy Fund had an initial gross exposure of 160% and an initial net exposure of 75% with the longs at 117.5% of equity and the shorts at 42.5% of equity. From July 3, 2006 the initial gross exposure is now 180% with the longs at 127.5% of equity and the shorts at 52.5% of equity.

---

When I started the virtual model Time-Blended Hedge Fund I decided to use a holding period of four years. I would now suggest forming two year long and short portfolios every month. This will ultimately result in 24 long/short two-year portfolios spaced one month apart.

I have used a quarterly basis for the two-year portfolios shown on this web site because weekly updating of the web pages for 24 monthly portfolios would be a rather overwhelming and unwieldy project. Once established, the portfolios remain unchanged, except for mergers, bankruptcies or a major change in underlying fundamentals. (1)At this time - March 27, 2007 - there are currently 10 active portfolios. To make the adjustment to 8 portfolios will require closing out Portfolios 1, 2, and 3 on April 2, 2007. The virtual model Hedge Synergy Fund will then be reduced by the equity in Portfolios 1 and 2. Essentially it is the equivalent of paying out a “virtual” dividend equal to the equity of those two portfolios. The equity in Portfolio 3 will become the beginning equity for the new Portfolio 11 being established on April 2, 2007.

The difficulty with the above was figuring out how to calculate the new investor equity (as opposed to the new fund equity). I calculated that one should take the percentage of the new fund equity relative to the old fund equity — 82.20% — and multiply that percentage by the number of “virtual” investor shares outstanding (252,265). This gave me a total of 206,933 shares (rounded to the nearest share). Multiplying this by the NAV of $150.94 results in a new investor equity of $31,297,824. This represents the investor equity as of April 2, 2007 (the beginning of Portfolio 11). This figure of course contains the investor equity from Portfolio 3 since that equity represents the equity being invested in Portfolio 11. The difference between the total portfolio equity of Portfolios 1 and 2 of $7,204,759 and the reduction of the investor equity of $6,778,981 (old investor equity $38,076,805 minus new investor equity $31,297,824 = $6,778,981) represents the equity of the “hypothetical” hedge fund management ($435,778).

For the last two-and-a-half years I have been looking for the optimum “fixed” net exposure that would produce the maximum return in a rising market and a break-even return in a falling market. This is based on the fact that I have no ability whatsoever to time the market and figured it was best to leave the net exposure alone. I have since come to the conclusion that while one cannot know when a market will turn, there comes a point when one is pretty certain that things have changed. Once it becomes apparent that a bear market has begun, then it makes sense to take a defensive position by using a lower net exposure. The same thing applies at the market bottom. While trying to time it is futile, eventually there comes a realization that a bull market is underway. While one may lag 3 to 6 months behind the event, the fact that one is using a hedged strategy means that the damage done once the market turns and before finally adjusting the net exposure should be minimal.

Basically, it is better to be late than early (if your properly hedged). It seems to me that going to a lower net exposure prior to the market falling is the same as trying to time the market. Going to a lower net exposure after the fact is simply responding to something that has already happened. I believe it might be a good idea to use a 120% net exposure when the market is rising and a 20% net exposure when it is falling. The original net exposure of 75% was based on an intuitive guess. It was also based on trying to find a single net exposure to use in all market conditions. Because I have decided to go to 20% when the market is falling, I believe it is possible to use a higher net exposure when the market is rising. Since there is no clear indication of the market turning, logic would dictate that I currently go to 120% net exposure. The problem is, I do not know for sure how 120% net exposure will perform once a bear market gets underway. I believe it would be prudent to leave well enough alone and stay with 75%. Not until we go through a full market cycle will I perhaps have an understanding of the relationship of my net exposures to market performance and know what the optimum net exposures should be.

Being successful in the long run does not come from trying to guess the future but by doing the correct thing at the present moment.

---

LEVERAGE
8/20/07

The last few weeks have been rather interesting. One thing that has become rather apparent is that I have quite a bit in common with some of the best known quantitative funds. It appears that I am not the only one to experience the world turned upside down. What I find especially interesting though is the amount of Schadenfreude associated with the performance of the quant funds.

It seems that the press is having a field day reveling in the fact that the quant’s value stocks took a rather large hit while their short stocks rose in price. The pundits theme is that the losses were due to poor stock selection. Actually the problem was not due to stock selection but rather the excessive use of leverage.

Due to the use of high amounts of leverage by various hedge funds, the subsequent forced sale of long stocks led to the vicious cycle of lower stock prices leading to more forced sales. The same held true for the short stocks. The forced coverage of the shorts to satisfy margin requirements caused the prices to rise leading to further forced coverage of shorts.

Because of this, there is now a large divergence of the values of the long and short stocks that is not wholly justified by the underlying fundamentals. While the longs may very well deserve a lower valuation in light of the credit crisis I do not see why the shorts should suddenly deserve to have a higher valuation.

The arbitrage road is not always smooth and it does not always run in a straight line. It is a road of twists and turns running through hill and dale. The most important thing to remember when traveling it is to make sure you have enough provisions to get to the end. While John Maynard Keynes once remarked “the market can remain irrational a lot longer than you can remain solvent” it does not always have to be the case. As long as someone is prudent in their use of leverage, while they may take a hit or two, they should be able to stay in the game and in the end claim the prize.

I am of course aware of the fact that this a (free) virtual hedge fund and therefore immune from investors clamoring for refunds. Even so, if someone wanted to establish a Time-Blended Hedge Fund, they could insulate themselves from sudden panics and irrational market moves by not using excessive leverage and by utilizing a closed end fund as their investment vehicle. While a major drawdown would lead to a discount of the share price to the NAV, it should only affect those who were prone to panic and speculation. If someone panics and sells at a discount, so be it. It only means that someone else who is focused on the long run is getting a bargain.

While I know the above sounds a touch arrogant, it is based on the dynamics of a long/short hedge fund utilizing a long term investing philosophy. The fact is there will be times of excess market speculation or panic that could result in the underperformance of the NAV. This should lead to a greater divergence of the long and short portfolios which in turn should result in excess profits being earned in the future as the respective portfolios finally revert to the mean. Therefore the value of the closed end fund would more than likely oscillate like a pendulum around the NAV. If someone is patient they should be able to pick up shares at a discount and then hold them to earn an enhanced return due to the discounted purchase price.

---

DISCONTINUOUS EQUILBRIUM
9/07/07

The disconnect continues. July of course was a real mess but things starting looking a bit better in August, though the performance of the short and long portfolios were still at odds with their historic relationship (I don’t mean historic in relation to this web site, I mean historic as in the last 50 years).

Unfortunately the first week of September has continued the pattern with the longs going into free fall while the shorts either rise or fall only slightly. I do not mind the longs losing, that is the nature of the markets, what I find disturbing is the shorts acting so contrary. Without the support of the shorts falling in tandem with the longs (and hopefully falling even faster) there is no effective hedge.

I believe the current situation is being caused by three things. The first is the fact, widely reported, of forced selling of long and short positions due to margin calls. This results of course in the longs falling and the shorts rising.

The second thing, I believe, is that certain quants have simply reversed their signals and are actively shorting those stocks that in the past they would be long and going long those stocks that in the past they would have shorted. This can be rather lucrative in the short run and probably explains how certain quant funds have managed to recover so quickly. The problem with this strategy is being able to know when to reverse directions since at some point the original equilibrium will be re-established.

The third is the usual activity of momentum players jumping on whatever is happening at the moment. They are simply mimicking the market moves and as usual will probably be caught out when things turn.

Since I do not advocate reversing the portfolios and due to the fact that hedging seems ineffectual at the moment, I have made the decision to go to cash (OK, I have made the decision to go to virtual “cash”). This idea just occurred to me yesterday and quite frankly while I never had considered it before it seems the only sensible thing to do. As of September 7th I will simply hold the NAV static. This does not mean I think the market is going to crash tomorrow. Quite frankly, if the long and short portfolios are not working it doesn't matter whether the market goes up or whether it goes down since either way you will either seriously underperform the market or even worse, lose money.

I will wait until October 2nd when I put together Portfolio 13 to decide if I will fund the long and short portfolios. If I do not do so at that time, I can always "fund" the portfolios anytime during the 4th quarter just as I have gone to “cash” during the 3rd quarter.

While the virtual Hedge Synergy Fund will be in “cash” and the NAV frozen, I will continue to publish the results of the quarterly long and short portfolios and will continue to show the performance of the Risk/Return chart. The reason for this is two fold. One, I need to know what would have happened if I had not gone to "cash" and two, I need to monitor the performance of the long and short portfolios (which means updating to Portfolio 13 on October 2nd). When it appears that things have returned to normal (or at least to what passes for normal in the stock market) I will then "fund' the virtual Hedge Synergy Fund.

Sometimes when you don't know which way to turn, the best thing to do is just sit on the sideline.

---

TRADE-OFFS
9/14/07

Instead of asking what the best net exposure should be, I think that the question could be better framed by asking “what is the best long/short ratio”. When it comes to long portfolio to short portfolio ratios everything is a trade-off. What one needs to do is ask what is the most important feature provided by each ratio and what is the secondary feature. The most important feature of a bear market ratio is the ability to try to earn a positive return in a down market and the secondary feature is to try to capture some of the upside market moves during bear corrections and when the bear bottoms out and a new bull market starts. While I have previously been leaning toward a 20% net exposure I now believe that a ratio of 1 to 1 is probably the best which of course is a 0% net exposure with the longs at 90% of equity and the shorts at 90% of equity (given 180% gross exposure).

It is a foregone conclusion that in a bull market the shorts will produce a negative return. The most important feature for a bull market ratio is to maximize the upside return of the longs by trying to minimize the negative return of the short portfolios. The secondary feature is to try to provide some downside protection during bull market corrections and when the bull finally tops out and heads down into a bear market. I have previously written about possibly going to 120% net exposure which gives one a ratio is 5 to 1 (given 180% gross exposure). While this would be fine in an up market I believe it provides too little protection in a down market. It is my belief that a 4 to 1 ratio is probably the best. This results in the longs being 144% of equity, the shorts 36% of equity and the net exposure being 108% when using 180% gross exposure.

As stated previously, the ratios should only be changed based on a change of the market that is indicated by a lagging indicator. To try to anticipate market changes can result in a large lost opportunity cost if you switch to soon in a bull market and possibly result in large negative returns if you switch to soon in a bear market. I believe that a properly hedged position should protect one when the market turns but as the July debacle illustrates, there are no guarantees.

When I decided to vary the net exposure I envisioned only two scenarios, the use of either a low net exposure or a high net exposure. As events have unfolded it has become apparent that a third scenario is also needed, the use of 100% cash.

I believe it would probably be a good idea to go 100% cash anytime the NAV has declined over 10% from a previous high. This occurred on July 27th. Unfortunately I did not even consider the idea of going to cash until September 6th at which point the Hedge Synergy NAV was down over 15%. Hindsight is always 20/20. Once it appears that the relationship between the long and short portfolios has normalized, one can then re-establish a hedged position.

As for switching from high to low net exposure, I believe that one should wait until it is apparent that a change of market direction has taken place. The best way to try to determine this is by using a lagging indicator such as a moving average.

Using a moving average with a long only strategy is pretty much a waste of time due to the fact you lose too much of your return waiting for a signal to switch from stocks to cash and vice a versa. On the other hand when using a hedge strategy you will hopefully lose less than the market when a bear market appears and you will hopefully capture some of the upside when a bull market gets underway. Also, by using leverage in an up market and trying for positive returns in a down market one can hopefully overcome the limitations of using a moving average indicator.

In using a moving average one is faced with a trade off. Using a short time period moving average will result in a faster response but will also generate a lot of false signals. Going to a longer time period moving average will give one less false signals but will result in a much longer delay. Since I am only concerned with cyclical bull and bear markets I have concluded that using a combination of a 300 day average of the S&P 500 and a 20 day average of the S&P 500 gives a fairly satisfactory result in determining major market moves with a minimum of false signals.

Therefore I propose the following rules:

Rule 1 – When the 20 day moving average is above the 300 day moving average use a high net exposure and when the 20 day moving average is below the 300 day moving average use a low net exposure.

Rule 2 – If the NAV has fallen more than 10% from its previous high, go to 100% cash.

Rule 3 – If you are at 100% cash, re-establish your hedged position based on one of the following occurring:

• If the 20 day moving average is above the 300 day moving average and the high net exposure returns (see Risk/Return chart) show a definite uptrend, establish the high net exposure hedge.
  
• If the 20 day moving average is below the 300 day moving average and the low net exposure returns (see Risk/Return chart) show a definite uptrend, establish the low net exposure hedge.

Given that I am using quarterly portfolios, I only intend to change net exposure at the beginning of a quarter based on the state of the moving averages at that time. The one exception is if I am going from 100% cash to a hedged position (which can occur during the quarter) then the net exposure will be based on the current state of the moving averages at the time I re-establish the hedge.

---

GOING IN REVERSE
9/28/07

While I am a big believer in the long term reversion of value and growth stocks to their mean, I am currently caught in a dilemma. It appears that both the value and growth stocks have been pushed to extremes. That is, the value stocks were bid up faster than they should have been and the growth stocks have been pushed down farther than was justified. This is due to the fact that a large number of funds were unknowingly following the same strategies. While I am worthless at divining the future, the present predicament is fairly clear. When the market rises, the longs have lagged and the shorts have risen faster. When the market falls, the longs have fallen farther and the shorts have fallen less.

If we are in a period of re-adjustment then the sensible thing to do would be to reverse the hedges. I feel that such a move is totally heretical but given the current state of the market it seems to make sense. If we enter a bear market, the growth stocks might just continue to provide enough resistance to mitigate the downturn. If the bull market continues and we experience a speculative blow-off then the growth stocks will more than likely lead the way. Therefore, as of October 2nd, I am going to the 108% net exposure hedge but with the value stocks as the shorts and the growth stocks as the longs. At the end of the fourth quarter I will then re-evaluate the long and short positions. Because I am in “virtual cash” the NAV as of Friday is the same as this coming Monday, October 2nd, therefore I will be starting the fourth quarter with the closing stock prices as of Friday, September 28th instead of the closing prices of Monday, October 2nd

---

VALUE vs. GROWTH
10/26/07

Value trumps growth... until it doesn't. While value will outperform growth over the long run, over the short run it does not do so consistently. There are periods when value outperforms growth and periods when growth trounces value. To maximize return one must know when to be long value and short growth (long = value) and when to be long growth and short value (long = growth). What one needs to do is be able to determine which trend is dominant. The above charts attempt to do just that. The charts do not try to predict the trends but rather only show which trend is dominant based on current data.

While I previously based my decision to go to "virtual cash" on the fall of the Hedge Synergy NAV I now believe any switch should be based on the relative performance of the value stock portfolios to the S&P 500. Just because the NAV is producing a positive return does not mean that the value stocks might not be underperforming the growth stocks. One needs to concentrate on how the value stocks are performing in relation to the market.

I should mention at this point that is not my intention to switch back and forth willy nilly. Any change in hedge strategy should only be made in extreme cases. This is why I propose waiting until the value stock portfolios have lagged the market by 5%. To try to capture every moment that the value stocks underperform the growth stocks is not only is an impossible task, it is very expensive in terms of time and transaction costs.

By using relative performance one can identify two types of situations. The first is the classic speculative market that is best illustrated by the tech bubble of the late 1990's. The growth stocks rose at such a stupendous rate (no other adjective could do justice) that they completely eclipsed the value stocks. In this case, it is fairly intuitive that switching the long portfolios from value to growth and the short portfolios from growth to value would be a no-brainer.

When the growth stocks finally hit a wall and started down it wouldn't have taken long before the growth stocks negative rate of return underperformed the rate of return of the value stocks signaling a switch from "long = growth" to "long = value". Eventually as the S&P 500 300/20 day trend line fell below negative 3%, one would have switched to a 0% net exposure with the value stocks being long at 90% of equity and the growth stocks being short at 90% of equity.

The second scenario is a sudden reversal of the value and growth performance. For an example look no further than the current credit crunch. The value stocks went down at a very fast clip and the growth stocks briefly followed before turning around and heading up. As you can see it did not take very long for the value stock portfolios to open up a negative 5% gap with the S&P 500.

Previously I had stated that any hedge strategy changes should be based on three rules. I believe that they can be reduced to only two rules. They are:

Rule 1 – When the S&P 500 300/20 day trend line is above 0% use a high net exposure and when the S&P 500 300/20 day trend line is below negative 2% to 3% use a low net exposure (see chart above).

Rule 2 – If the Value/S&P 500 Trend line is below negative 5% then use "long = growth" and once the Value/S&P 500 Trend line (or perhaps the Value/Growth Trend Line) rises back above 0% then switch back to "long = value" (see chart above).

This will give you four different hedge strategies:

• High net exposure / long = value
• High net exposure / long = growth
• Low net exposure / long = value
• Low net exposure / long = growth

Please remember, the Value/S&P 500 Trend Line and the Value/Growth Trend Line are meant to only apply to the portfolios on this web site and are not meant to be indicators for the general market. Also remember that the Trend Lines do not predict changes they simply record current events.

---

VOLATILITY
11/13/07

On Monday I watched as the NAV melted away. My first reaction was to try to avoid the mistake I made this summer when I hesitated and waited too long to take any action. I realized it would take a few weeks before my charts would signal a switch from “long = growth” to “long = value” and perhaps I should just take the rapid drop in the NAV as a sign to switch strategies. On further reflection I came to the conclusion that being impetuous was as much of a sin as procrastination. I believe that it is best to wait to determine which way to go between “long = growth” and “long = value”.

I could see that some sort of action was called for though since the volatility was getting out of control. I now believe that if one needs to switch to a “long = growth” strategy that they should also go to 0% net exposure regardless of what the S&P 500 300/20 day trend indicates. This is because the volatility of the growth stocks is so much greater than the value stocks. While a 108% net exposure might work for “long = value”, it is much too risky for “long = growth”. I have decided to have the virtual Hedge Synergy Fund go to a 0% net exposure and to make the change immediately, not waiting for Friday.

---

VOLATILITY...continued
11/16/07

If I had waited until Friday the 16th, the 108% net exposure “long = growth” strategy would have been up 4.72%. Having changed to a 0% net exposure as of Tuesday I am up 3.34%. While it would be nice to be up the higher figure, leverage cuts both ways. This is illustrated looking at the “Hedge Fund Performance” chart as of 11/12/07. All the gains since 9/28/07 have been wiped out in about a week.

The following chart directly compares the performance of the five net exposures as of 11/12/07. It begins at 9/28/07 when the virtual Hedge Synergy Hedge Fund went to a “long = growth” strategy (see Hedge Fund Performance chart). The higher net exposure strategies rose the highest and fell the furthest resulting in the high net exposures having the lowest returns and the highest volatility. The blue line in the chart represents the gross return of the 108% net exposure used by the virtual Hedge Synergy Hedge Fund at that time. As one can see, the ending result was that all the gains of the 108% net exposure strategy were wiped out and it was back to where it had started on 9/28/07.

From September 28, 2007 to November 12, 2007

The next chart directly compares the performance of the five net exposures as of 11/12/07. It begins at 8/24/07 when the Value/S&P 500 Trend Line signaled a change from “long = value” to “long = growth” (see Risk/Return chart) . Again the high net exposure strategies rose the highest and fell the furthest. While the ending returns for all net exposures are still fairly decent, the highest net exposures still had the lowest returns and the highest volatility. These two charts also show how much it cost me not to have changed the Hedge Synergy Fund strategy sooner. As I have mentioned before, hindsight is always 20-20

From August 24, 2007 to November 12, 2007

I believe this amply demonstrates that when using a “long = growth” strategy that given the high volatility of the growth stocks, one should definitely use a 0% net exposure. By lowering the volatility I should also be able to buy more time to make a decision on switching between "long = growth" and "long = value" hedge strategies using the Value/Growth and Value/SP 500 trend lines.

This will give you three different hedge strategies:

• Long = Value / High net exposureLong = Value / Low net exposure
• Long = Growth / Low net exposure

---

5 WEEKS VS. 10 WEEKS
12/14/07

Several weeks ago I switched from using a 10 week Value/Growth Trend Line to a a 5 week Value/Growth Trend Line. My reason for doing so was based on the fact that the "long = growth" strategy was highly volatile and waiting for the 10 week trend line to respond could result in a large drawdown. As some of you may have noticed, a few weeks ago I made the decision to use 0% net exposure whenever I switched to "long = growth". Because of this the volatility has fallen considerably. While using a 10 week moving average will take longer to generate a signal to change strategies it will also help to reduce the number of false signals. My believe is that while it will take longer for a signal and consequently will result in a larger drawdown than a 5 week moving average, due to the lower volatility of using 0% net exposure the drawdown should be manageable.

---

OCCAM'S RAZOR
1/04/08

Originally I wanted to keep things simple and just use the Value/Growth trend line to signal when to switch from a “long = value” strategy to a “long = growth” strategy. The problem was, when switching to a “long = growth” strategy using 108% net exposure the volatility was dreadful. I decided it was best to go to a “long = growth” strategy only when absolutely necessary. Since the Value/S&P 500 trend line only signaled a switch to “long = growth” once the value stocks took a nose dive beginning with the credit crunch (which definitely required a switch in hedge strategies) I decided to go with the Value/S&P 500 indicator.

When I realized I should use a 0% net exposure any time I switched to the “long = growth” strategy it solved the volatility problem. Because the Value/Growth trend line is a direct comparison between the value and growth stocks as opposed to the Value/S&P 500 trend line which is an indirect comparison at best, I have decided to use the 10 week Value/Growth trend line exclusively for signaling a switch between the “long = value” and “long = growth” strategies and switching back from “long = growth” to “long = value”.

Since the Value/Growth trend line signaled a switch to “long = growth” between August 5, 2005 and March 31, 2006 I have updated the charts on the “Risk/Return” pages to reflect this. The change of strategies during this time period produced a marginally higher return than not having switched at all.

It also signaled a switch three weeks earlier than the Value/S&P 500 trend line for the second switch of “long = value” to “long = growth” (a signal on August 3, 2007 instead of August 24, 2007). The ironic thing is, while it produced a quicker signal for that change, it also produced a slightly larger drawdown which wiped out the small gain achieved from the first switch. Even so, over the long run, the Value/Growth indicator should produce a faster more accurate signal resulting in better returns.

To recap the rules:

Rule 1 – If the Value/Growth trend line is below negative 5% then use "long = growth" and once the Value/Growth trend line rises back above 0% then switch back to "long = value".

Rule 2 – When using "long = value" if the S&P 500 300/20 day trend line is above 0% use a high net exposure and if the S&P 500 300/20 day trend line is below negative 2% to 3% or if you switch to "long = growth" use a low net exposure.

This will give you three different hedge strategies:

• Long = Value / High net exposure Long = Value / Low net exposure
• Long = Growth / Low net exposure

---

BREAKER SWITCH
1/20/08

Even though I do not play chess I found myself spending the week-end looking two to three moves ahead (actually two to three weeks ahead). I came to the realization that while the Value/Growth trend line might work rather well in a slow and orderly phase transition, it might not be the best way to go when there is a sudden and violent overthrow of the value and growth status quo. Using the Value/Growth trend line it would take an additional decline of the NAV of approximately 25% or more to trigger a signal in the coming week of 1/25/08. It would take a decline of over 16% from the current NAV level to trigger a signal in the week of 2/1/08 and a decline of over 6% to trigger a signal in the week of 2/8/08.

I would like to propose another rule to use when there is an abrupt change in sentiment. That is, if the Variable strategy declines over 10% from a weekly high, then switch strategies. A decline of that magnitude can only mean that the value and growth stock trends have undergone a major change. To wait any longer will only cause a greater loss.

Why not just use a 10% decline as a signal all the time? Because in times of a slow phase transition between value and growth stock trends, the Value/Growth trend line should give you a signal before you have a 10% drawdown. If you can make a change with less than a 10% drawdown, that is a good thing. If not, then at least one has a rule to fall back on to limit one’s losses.

Using this rule would not have effected the first switch from “long = value” to “long = growth” and then back to “long = value” (the period from 8/05/05 to 3/31/06). It would have effected the second switch from “long = value” to “long = growth” though. It would have signaled a switch one week earlier on July 27, 2007. I have updated the “Risk / Return” pages to reflect this fact.

---

HEDGE REVERSAL
1/22/08

I found myself in the paradoxical position of sitting around all day rooting for the Variable strategy return to decline past 10%. While 9.44% down is not the same as 10% down, given that this did not come about over several weeks but instead in a matter of days and more significantly because the shorts (value stocks) are actually rising while the longs (growth stocks) and the market are both falling, I am fairly convinced that we have seen a major change in the relationship between value and growth stocks. Due to the volatility of the market I am not waiting until the week-end to switch strategies from "long = growth" to "long = value" but plan to do so immediately. Also, since the S&P 500 300/20 day trend line is below -3%, I will be using a 0% net exposure. It will probably take a day or two to redo the Excel spreadsheets and update the web site but I intend to switch strategies as of today.

---

WEEKLY PORTFOLIO RETURNS
03/23/08

In looking over the Weekly Returns web page I realized that the beginning equity of the individual portfolios should be re-balanced at the beginning of each quarter just like the individual long and short portfolio investments are. As it is now, the individual portfolio equity amounts tend to drift which skews the weekly rate of return of the individual portfolios.

I should hasten to add that this problem is confined to the reported weekly returns of the individual portfolios that appear on the Weekly Returns web page. It has no impact on the Hedge Synergy NAV and the weekly rate of return of the value and growth stock portfolios which are based on the total equity of the individual portfolios.

Originally I wanted to track the returns of the individual portfolios since I was constantly making changes to my stock selection process. I wanted to see how the various changes impacted each new portfolio. Since I have only been doing minor tweaking of my stock selection process in last couple of years (in contrast with the major changes I have made in portfolio management) the weekly rate of return of the individual portfolios is not that important. In truth, until this week, I do not know if I have even looked at them in the past year.

I guess I could make a copy of my original Excel spreadsheets and spend a few hours every week taking the quarterly beginning fund balance and dividing it equally among the portfolios and then recalculate the weekly gain/loss percentages of the individual portfolios. Given the demands on my time it is a project that could take a several months. Considering the information value of the exercise though, it would probably not be worth it. No matter which way I go with the prior data, beginning with portfolio 15 I will be dividing the beginning quarterly fund balance equally between each portfolio.

---

QUANTITATIVE vs. INTUITION
04/24/08

On Wednesday the Variable NAV had a drawdown in excess of 10%. I concluded that since it had gone down over 10% I should therefore switch strategies. The problem was I had a strong feeling that this was not the right thing to do, at least not at this time. While I believe in trying to quantify all my actions it seemed to me that relying on a fixed rule when things just do not seem right could be counter productive.

After analyzing the situation the thing that was bothering me was the degree of momentum of the drawdown. In August 2007 when the Hedge Synergy NAV was headed straight down I reasoned that if I was doing the opposite of what I was currently doing I would begin to make a profit. At the time I had never considered reversing the hedge from long value and short growth to the opposite, long growth and short value. Even though I wanted to do something immediately I felt totally constrained. My intuition was completely overridden by my then current set of rules so it wasn't until September that I decided to go to “virtual cash” since I still could not quite get my head around the idea of reversing the hedge.

Eventually I came to the idea of reversing the hedge between value and growth. When the same situation occurred in January 2008, when the value and growth trends showed a very strong reversal, I had the overwhelming feeling that I needed to reverse the hedges immediately even though the drawdown was not quite 10%. There was a very strong downward momentum of the NAV and once I reversed the hedge that momentum continued but in reverse and subsequently carried the NAV upwards.

Now, while I may be wrong, I have the feeling that reversing the hedges even with the drawdown hitting 10% is not the correct course of action. The momentum that drove the first two situations just does not seem to be there. If I reverse the hedges and the current phase transition fades out and the value stocks become dominate, I would have to wait for a further drawdown before I would finally be able to go back to long equal value.

I like the idea of following a certain hard and fast set of rules but I have come to realize that while having rules as a guideline is a very good idea, some intuitive input is probably also needed. If the drawdown continues I may at some point have to reverse the hedge, but for now, I would rather wait.