Apr 01 2009
Wall Street Transcript Interview with Dave Young, President of Paragon Wealth Management.
By Daniel Kelley
TWST: Can you start with an overview of Paragon Wealth Management and your investment philosophy there?
Mr. Young: I started and sold several successful businesses back in 1986. As a resultof the sale of those businesses I had a significant savings that I needed to invest. After a lot of research I wasn’t able to find a firm that would do much more than take a buy and hold – hope and pray approach to investing my money. I was unwilling to put my life savings at risk with that approach and decided to manage the money myself.
I started out 23 years ago using a fairly simple approach based on technical analysis. Over the years our pro-active management strategy has evolved into one that is primarily quantitative with technical and fundamental inputs. After years of managing money in the markets, I still believe that there are much better investment strategies than simple buy and hold.
TWST: Tell us a bit about the client base that you have, who are your typical clients?
Mr. Young: Most of our clients are individuals and families, but we also manage money for businesses and non-profits. The majority of our clients are business owners, retirees and medical professionals. We actively manage all types of traditional and retirement accounts.
TWST: What services do you offer to your clients?
Mr. Young: Our primary focus is money management. We offer several portfolio options, some which are strategic and others that are more tactical. We are entirely fee based and do not sell any financial products or receive commissions.
When a client visits us for the first time, we determine what level of risk they would like to have their money managed, and then we put them in a portfolio that is reflective of that risk.
TWST: What portfolios do you have at present time to offer your clients?
Mr. Young: Our most popular portfolios are Managed Income which is conservative and Top Flight which is growth oriented. Many of our clients are in some combination of these two portfolios, depending on their risk tolerance. By combining the two portfolios clients are able to create a very custom, actively managed portfolio that is dialed in to their individual tolerance for risk. Both portfolios are based on tactical strategies and are constantly adjusting to the markets.
We also have strategic portfolios. Those portfolios are for clients whose primary focus is tax efficiency and want a portfolio with low turnover. Our strategic portfolios are traded much less actively and seek to generate long-term capital gains.
TWST: These have been a tumultuous few months in the market for investors, for both fixed income and equity. How have you done at Paragon?
Mr. Young: I have been through several rough markets during my money management career. We made it through the 1987 crash untouched. We also did relatively well during the 1998 Asian Crisis and the 2000-2002 bear market. This bear market has come together differently than any I have ever experienced. It really has been the perfect storm.
Our models are built to move us towards cash as markets become overvalued and into equities when they are undervalued. At the end of 2007, our models indicated the markets were at fair value. Unlike previous bear markets, this time valuations were not excessively stretched. Therefore we did not have large cash positions going into this bear market.
Also, our models are constantly measuring the strongest asset classes and moving into those asset classes. In previous bear markets moving towards strength has always cushioned the downside. Usually, there is always a bull market somewhere that you can benefit from. This time, there was virtually nowhere to hide. There was no bull market anywhere except treasury bonds.
While I’m not ever happy with losses, our portfolios did relatively well in 2008. To put it in perspective, in 2007 Top Flight returned 17% versus 5.5% for the S&P 500. We were able to triple the S&P 500 because our Top Flight was primarily invested in international markets at that time.
In 2008, those same international funds were down 47%. Top Flight, on the other hand was only down 33.8%. This year we experienced the worst declines Top Flight has ever seen. Over the past eleven years -13.6% had been our worst year up until this bear market.
Managed Income also did better than most conservative portfolios. Most of our clients have a mix of Managed Income and Top Flight, depending on their risk tolerance. As a result, that mix provided significant protection to our clients and most of them fared much better than the market indexes last year.
TWST: What is your outlook for 2009? Do you see any light at the end of the tunnel?
Mr. Young: The market is unbelievably oversold at these levels. We are back to the same levels we were at 13 years ago. When you consider the growth of the population, the advances in technology, and all of the gains in productivity it is hard to believe the market is priced the same as it was then. Stocks are incredibly cheap, and they are becoming more and more undervalued each time the government announces a new solution.
Back in late September, Fed Chairman Ben Bernanke and treasury secretary Hank Paulson initially scared investors to death with a very public and emotional plea to congress requesting $700 Billion to bailout the banks. Next, the market sold down hard in October and November because of the uncertainty surrounding a change in political leadership.
After the election the market actually rallied over 20% as investors begin to believe that Obama would govern from the center, not from the left. At that point most market participants thought that we had seen the lows and would move towards recovery.
Then President Obama started talking. He promised stimulus and delivered pork. He promised fiscal responsibility and is projected to match George Bush’s entire deficit in his first 20 months of office. Every day he comes out with another plan and another program. His treasury secretary seems lost. His policies sound more like socialism than free market.
Every time Obama talks the market tanks. Unfortunately, he likes to talk. Selling short every time Obama speaks has actually become a trading strategy because it was so successful.
I believe that if it weren’t for the foolish political mistakes this market would have turned back positive around 8000 on the Dow. Because of the extreme levels of fear we are in a spot where valuations don’t matter.
I believe that the markets will turn positive this year. This is very simplistic, but when we get to a point where President Obama can go on television and speak…and the market goes sideways or up….then I think we will be very close to a bottom.
TWST: Please describe your investment process for the Top Flight portfolio. How do you attempt to control risk?
Mr. Young: Top Flight is managed using two unique groups of quantitative models. The first group of models is proactive in nature and determines which areas to invest in. The second group of models is protective in nature and determine how much of the portfolio will be invested in equities and how much will be in cash at any point in time.
The proactive set of Paragon models is designed to identify trends and measure velocity within the universe of available market styles, sectors and industries. When trends are identified, the portfolio stays invested in those market styles, sectors or industries until certain exit criteria are met. When an exit criterion is met, the funds are rotated into other areas that currently meet the model’s recommendations. This rotation is ongoing, and the models are constantly adapting to current market conditions.
The protective set of models is designed to reduce risk while achieving a high return on investment. These models determine how much of the portfolio will be invested in the market. This percentage is based on how much risk the model measures at that point in time. When the model shows that there are high levels of risk in the markets, the portfolio holds more cash. When the model shows that there are low levels of risk in the markets, the portfolio becomes fully invested. The equity exposure in the portfolio changes depending on market conditions and will range anywhere in between 0% and 100% net long.
Top Flight invests primarily in exchange traded funds that concentrate investments in various classes of equity securities, which provides your portfolio with the greatest focus and flexibility.
TWST: What has been the return of the Top Flight portfolio since its inception?
Net of all fees, for the eleven year period from 1998-2008, Top Flight has delivered a total return of 242.1%. During that same period of time the S&P 500 returned only 11.7%. On an annualized basis, that works out to 11.93% for Top Flight versus 1.03% for the S&P 500.
TWST: We haven’t discussed your conservative portfolio. Could you expand more on your Managed Income portfolio.
Mr. Young: This portfolio’s objective is to generate higher returns than bank certificates of deposit or traditional bond portfolios without the volatility normally associated with the stock market. This portfolio is managed using some of the same techniques that Top Flight, Paragon’s growth portfolio originally pioneered, but with a much more conservative approach.
The principal asset classes we rotate between include bonds, real estate, utility stocks, bank loan funds, convertables, preferreds, alternatives, low volatility funds and money markets.
This portfolio is managed by processing market data through separate quantitative models that measure asset class desirability. Paragon also uses models to screen several thousand ETFs and mutual funds within the target asset classes to determine which funds are ranked highest. At any given time, the portfolio may include 8 to 12 positions representing various asset class combinations.
Occasionally, as opportunities present themselves, a small portion (less than 20%) of the portfolio will be allocated to low risk / high probability short-term trades using ETFs or equity-based mutual funds.
To preserve capital, the portfolio will normally exit out of volatile positions at a much earlier stage than Top Flight, Paragon’s growth portfolio.
TWST: What gives your firm its edge? What differentiates you from other wealth management firms?
Mr. Young: We have a philosophy that places a premium on proactive management, proven quantitative models and exceptional client service.
Our fundamental roots lie in money management. The methods that we use are very unique within the financial services industry. Most advisory firms simply build a diversified portfolio then wait and hope, but we actively manage our clients portfolios on a daily basis. This includes using proprietary quantitative models to measure, monitor and adjust our portfolios as market conditions change. These portfolios have a strong history of outstanding risk adjusted returns.
In the financial world, experience and judgment matter more than anything. We offer our clients a proven 23-year record of success working in all types of market conditions. Since we opened our doors in 1986, we have continually improved our investment methods and client services. When clients invest with us, they receive all the benefits and advantages of that experience.
As a registered investment advisor, we have a fiduciary responsibility for every client we serve. That means we have a legal obligation to put their interests ahead of our own. It is estimated that only 15% of all financial advisors meet this fiduciary requirement.
To make sure our interests are always perfectly aligned with our clients, Paragon advisors never sell financial products or receive sales commissions. We only receive management fees for managing our client’s accounts.
With us, there are no hidden fees or surrender charges. Unlike most investments, clients are free to move their money out of our investment programs at any time if their needs change or they are not completely satisfied with our services.
TWST: Last time we talked, you talked about how important it is to measure the amount of risk an investor is taking, not just returns. Do you want to tell our readers more about that?
Mr. Young: Since my firm was founded on the importance of reducing risk I obviously feel that it is very important. I believe that it is useless to compare returns unless you also compare corresponding risk. We use the Ulcer Index to measure risk.
The Ulcer Index is different from other risk measurement indexes, such as standard deviation, beta and the Sharpe ratio, because it does much more than simply measure portfolio volatility. Traditional risk indexes falsely assume that all volatility is bad. The reality is that investors welcome upside volatility-but deplore downside volatility. The Ulcer Index accounts for this basic psychological fact by ignoring upside volatility and penalizing downside volatility.
Since its inception from January 1, 1998 to December 31, 2008, the Paragon Top Flight Portfolio has generated an Ulcer Index rating of 8.9, compared to 19.31 for the S&P 500 and 49.32 for the NASDAQ. The lower the number, the lower the risk level.
TWST: Are there any other topics or issues that you would like to mention in this interview that we haven’t touched on?
Mr. Young: We are in a very difficult time right now and a lot of investors are simply putting their head in the sand and waiting for this horrible market to go away. That’s understandable. The fact is there is some history to this situation. We have been through 34 bear markets in last 100 years. We’ve had four bear markets that are in the same category as the one we are going through right now, that had declines of 50% and more. After each one of the bear markets we have gone through there are certain areas of the market that show extreme strength when the market finally reverses.
After past bear markets we’ve positioned ourselves in those areas of the market that have traditionally shown the most strength. Those areas have come out three to four times faster than the broad S&P indexes. For example, after the 2002 bear market we had the 2003 a bull market. That year, the S&P 500 was up 28.6% but Top Flight was up 50.3% that same year, because we moved into those areas of the market that do well after bear markets.
This type of bear market we are currently going through usually happens only once or twice in an investor’s life-time. It is also a once in a life-time opportunity. It is important for investors to be in the right places on the other side of this bear market.
TWST: Thank you. (PS)