The following explains the portfolio management strategy that I used from October 1, 2004 to May 16, 2008.

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".

TIME-BLENDED PORTFOLIOS

While the ability to select undervalued and overvalued stocks forms the basis of a long/short equity Hedge Fund, the timing of the purchase and short sale of the selected stocks has always been a problem. If a Hedge Fund Manager identifies a stock that is undervalued or a stock which is overvalued, it does not mean that the market will recognize the situation in the near term. One way to deal with the problem of stock selection timing is through the use of Time-Blended Portfolios.

Time-Blended Portfolios are a series of long-term portfolios established at regular short-term intervals all of which utilize the same investment style and stock selection criteria. The goal of Time-Blended Portfolios is to mitigate the risk involved in erroneous timing of stock selection.

TIME PERIODS

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 (see Valuation).

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 (see ESTABLISHING THE PORTFOLIOS below).

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).

ESTABLISHING THE PORTFOLIOS

The following is an example of how a Time-Blended Hedge Fund would work. If the goal is to establish a Time-Blended Hedge Fund, one would first find a group of investors who would subscribe to the Hedge Fund by investing a given amount every month for the two-year period. At the end of two years the Time-Blended Hedge Fund would reach maturity and be closed to any additional investment. The monthly investments would also require a two year lockup from the point in time when each of the long/short portfolios was created. The amount of monthly investment would vary depending on the performance of the Hedge Fund.

For example, one could start by issuing 10,000 shares at $100 a share for a total equity of $1,000,000. If, at the end of the first month the Net Asset Value (NAV) had risen by 3% (NAV = $103), then the second monthly long/short portfolios would require an equity investment of $103 X 10,000 shares or $1,030,000. If the NAV then dropped by 2% at the end of the second month (NAV = $100.94), the total equity investment in the 3rd long/short portfolios would be $100.94 X 10,000 shares or $1,009,400. One would continue on like this until the Hedge Fund was fully invested. When the Fund was in fact fully invested one would start to close out portfolios that had reached the end of their two-year term and to invest the proceeds in new portfolios.

The above example assumes no performance fees. Since the initial portfolio equity of the new portfolios should be an average of the total equity of all the previous portfolios and not just the investor equity, one will need to increase the number of shares issued to compensate for the reduction of the investor equity by the performance fee which is reflected in the NAV (see Portfolio Returns).

FULLY FUNDED HEDGE FUND

It is also possible and a lot easier if one just started a small personal investment fund using the above method. This would give one a chance to see if they knew what they were doing (always a good thing to know) and would eventually give one a full set of working value and growth portfolios. At that point they could launch a fully funded Time-Blended hedge fund using their existing value and growth stock selections.

One problem is the two-year lockup rule. Using the original subscription plan would result in a monthly series of two-year lockups, which means that approximately 4.2% of the total funds equity would be subject to withdrawal in any one month after the first two years. If, on the other hand, one uses a fully-funded Time-Blended Hedge Fund, the two-year lockup rule means that the entire fund would be subject to withdrawal once the fund reaches that mark.

One way of insuring a long-term investor commitment is to establish a closed-end fund as a holding company. The biggest problem with a closed-end fund is the possibility of its stock selling at a discount or a premium to the NAV. A discount obviously hurts current investors while a premium reduces return for future investors.

VALUE vs. GROWTH

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). I use moving averages of the value and growth portfolios along with moving averages of the S&P 500 to determine which trend is dominant and when to switch hedge strategies and net exposures.

The hedge strategy and net exposure changes are based on two rules:

Rule 1 – If the Value/Growth trend line is below negative 5% use "long = growth" and once the Value/Growth trend line rises back above 0% then switch back to "long = value" or if the Variable strategy declines over 10% from its previous weekly high then switch strategies.

Rule 3 – When using "long = value" and 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% 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

Please remember, the Value/Growth trend Line is meant to only apply to the portfolios on this web site and is not meant to be an indicator for the general market. Also remember that the S&P 500 300/20 day trend line and the Value/Growth trend line do not predict changes they simply record current events.

GROSS EXPOSURE

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 (see Exposure Drift - Graph).

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 (see Exposure Drift - Table).

NET EXPOSURE

Originally, I planned to hold the net exposure constant. This was because I am totally unable to time the market and so believed changing the net exposure by trying to guess the turning of the market a complete waste of time. I have since come to the conclusion that while one can not 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.

I believe it might be a good idea when using a "long = value" strategy to use a 108% net exposure when the market is rising and a 0% 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. Since I have now decided to go to 0% when the market is falling, I believe it is possible to use a higher net exposure when the market is rising. 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.

One thing I should emphasize is that I am not looking for a range of net exposures that will apply to all hedge fund strategies or to every long/short equity hedge fund. I am searching for the range of net exposures that will produce an efficient rate of return given my particular stock selection process and the volatility of my short and long portfolios.

ADJUSTMENTS

Because of exposure drift the long and short positions will need to be re-balanced at the beginning of each new quarterly portfolio. I have decided to simply adjust all long and short stocks positions so as to equally weight them by dollar amount.

There are two exceptions to equal weighting. The first is to leave any short stock that becomes subject to Restricted Stocks Reg-SHO unchanged.

The second exception is when a stock appears in a number of portfolios. I would suggest limiting the total dollar position for stocks appearing two times or more to a maximum of 2% of the total portfolio equity. If one has a stock appearing two times or more, one should subtract the maximum dollar amount allowed for those stocks from the total long or short portfolio amount and apportion the remainder equally among the other stock positions.

Monthly Performance of the Hedge Synergy NAV, Long Portfolios, Short Portfolios and S&P 500