Tip Sheet: Top Flight Portfolio Times Markets Profitably
July 16, 2004
By Lynn Cowan, Wall Street Journal
If market timing is uniformly evil and prone to failure, then somebody forgot to tell Dave Young.
Young, the President and Founder of Paragon Capital Management, has been timing the market on a grand scale since 1998, when he launched Top Flight Portfolio, a separately managed account with an official minimum investment requirement of $200,000. For the five years ended in March, the portfolio has generated a compound annual rate of return, net of fees, of 22.6%; for the year ended in March, it has returned 62%, according to MoniResearch Newsletter, which tracks the performance of market-timing portfolio managers.
Top Flight Portfolio has generated its return by doing exactly what your grandfather and broker warned you not to do: It refuses to buy and hold, and instead jumps in and out of mutual funds, trying to catch market swings at the right moment-in other words, market timing.
“A lot of things we do are completely contrary to conventional wisdom,” said Young, 48, who received a bachelor’s degree in business management from Brigham Young University.
Young’s career path is also contrary to the norm. A professional magician from 1977 to 1980, he quit because he was spending too much time on tour, away from his family. After running a number of businesses, including a llama farm, he again scaled back his work life in 1986, and started managing his own money, then his friends’ money. In 1992, he set up Paragon Capital Management as a full-fledged money-management business in Provo, Utah.
He launched the Top Flight Portfolio in 1998, choosing which funds to buy and sell based on a series of quantitative models that attempt to augur which way the investing winds will blow in the short term (one to three months) and longer term (three to nine months). One model that he uses quite often breaks the market’s trends into a variety of factors-price-to-earnings ratios, price-to-book ratios-and tries to identify all the different factors being used by fund managers, and how they are performing.
“It gives us a picture under the surface, as the money starts to move toward different styles and asset classes. Then we try to move ahead of them,” he said.
Young’s taste for quick portfolio change-and the term “market timing”- aren’t embraced by mainstream public opinion at the moment. In September 2003, New York Attorney General Eliot Spitzer launched an investigation into improper mutual-fund trading, probing whether the industry’s largest mutual-fund companies were allowing institutional investors to secretly hop in and out of funds, in contravention of their written policies and to the detriment of buy-and-hold investors.
But market timing, when done in an above-board manner, is a legitimate, if not controversial, investing strategy. As long as money managers aren’t cutting secret deals to allow market timing in funds that prohibit it, it’s not improper or illegal; in fact, some fund families, like Rydex and ProFunds, encourage timers. Still, the term “market timing,” has become so tainted in the past year that portfolio managers like Young have embraced new monikers, such as, “dynamic asset allocators” or “active managers.”
Young’s portfolio, which serves 140 investors and has about $30 million in assets under management, owns about a half-dozen mutual funds at any given time. Currently, it holds Rock Canyon Top Flight Fund (TOPFX), Acadian Emerging Markets (AEMGX), Ivy European Opportunities (EOAX) and Constellation Clover Small Cap Value (TCSVX), and about 20% of its assets are in cash.
One core holding is the Rock Canyon Top Flight Fund, which was launched in 2003 by Top Flight Portfolio’s former co-manager, Jonathan Ferrell. Although it is a separate entity from Young’s portfolio, it was launched using the portfolio’s short-term investing models, which have since been enhanced by the fund. Young uses Rock Canyon Top Flight to deploy his short-term investing strategies, putting between 25% to 50% of his assets into it. The fund’s total return in 2003 was 52.8% while its return in 2004 was 1.8% as of June 30, according to research firm Morningstar Inc.
Rock Canyon Top Flight Fund operates almost like a hedge fund, both buying stocks and shorting them, or betting that their value will fall. If you believe that Rock Canyon Top Flight Fund’s returns are worth trying to reproduce, then the fund seems to be saying that mid-cap value stocks are the way to go, that the consumer service and financial-services industries are going to be hot, and that four of your top five stock holding ought to be energy companies, according to data from Morningstar. But that’s only current as of the end of June, and can change on a dime, as evidenced by the fund’s yearly turnover of 2,731%.
And forget trying to classify the fund’s style: in 2003, Top Flight was a small-cap blend fund; it’s also been a mid-cap growth fund before becoming mid-cap value this year, according to Morningstar. Such sudden asset style changes are unusual in the mutual-fund world, where most managers are religious about hewing to one type of asset class and size, and try to keep turnover to a minimum, but it’s a safe bet that Top Flight Fund doesn’t particularly care how it’s classified, as long as the returns are good and investors are happy.
“Having Top Flight Fund available allows us to be true to our short-term models and solve and short-term trading issues we might encounter with mutual funds,” said Young, referring to the increasing reluctance of other fund managers to allow frequent trading.
Top Flight Portfolio’s remaining funds currently hold about 10% its assets apiece. Young said he may hold a fund between three to nine months on average before selling, although some are held for longer or shorter periods on occasion.
There are downsides to a portfolio dedicated to fast market moves. One obvious issue is tax efficiency-and Young will be the first person to say that Top Flight Portfolio is not for investors concerned about the short-term capital gains implications of high turnover. The funds within the portfolio have an annual turnover between 100% and 3,000%.
Those who are attracted to it tend to be foundations and pension funds that don’t face the same tax issues as individual investors, or individuals who are willing to overlook the tax hit for a higher return, said Young.
“A lot of our (individual) clients says, “I don’t care if I have to pay taxes on it,”” said Young. “They’re happy to pay taxes on the portfolio because their priority is to make good terms.”
Top Flight Portfolio’s stated indifference to tax issues is an anomaly among separately managed accounts products. Because investors in a separately managed account directly own the securities chosen by the portfolio manager, a key marketing strategy is to tout their customization and tax-flexibility features over that of mutual funds. What Top Flight does have in common with other separately managed accounts is its bar for entry-most such products have income requirements and initial investment minimums of $100,000 to $200,000, much higher than most mutual funds.
Because Top Flight Portfolio is a separately managed account and not a mutual0fund product, it’s not tracked by Morningstar or Lipper. Investors must rely on Young’s own self-reported results, or on those listed in publications like the MoniResearch Newsletter, a Woodland, Wash.-based market-timing newsletter founded in 1986.
Steve Shellans, the editor of the newsletter, said he audits the results of the market-timing portfolios he tracks by asking the managers for three investors’ statements. Shellans said he asks the managers to select investors who are representative of the portfolios’ performances, but realizes that the process is dependent on managers not cherry-picking the best performing portfolios. MoniResearch doesn’t accept incentives from the money managers it audits, charging them the flat rate of %275 apiece; Shellans said he has “no ax to grind” in terms of favoring one portfolio over another.
“This is a niche market that really has proven to be successful,” Shellans said of market timers.
Young puts it another way. “I’ve never had enough trust in the markets to buy and hold,” he said.
Lynn Cowan covers the securities industry for Dow Jones Newswires.