Σ1

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Currently all-long, mostly-equity positions:

• 50 shares EFA
• 100 shares SCHB
• 100 shares VEA
• 100 shares JNK
• 200 shares PBP
• 100 shares VTI
• 100 shares SPY

NAV: 36,604.55 USD.

Yesterday I made several trades. I bought BWX and WIP to close my short positions, while maintaining long positions in EFA and VEA, effectively going shorter against the USD.

Even though I have been emulate the CBOE S&P 500 BuyWrite Index (BXM) for somewhat less than PBP’s 0.75% expense ratio, I decided eat some crow and just buy some PBP. This saves me the hassle of trading options every month.

The fund is now has no short positions, other than cash, which currently costs over 1.6% to borrow. Current closing NAV of the Sigma1 Proprietary Trading Fund is $36,571.

Years ago, a successful friend of mine was telling me stories about his early Wall Street interviews with a big-name investing house.   One stood out to me.   The question:

If you had to invest $1,000,000 for a client, and your had only two choices, which would you choose?   (A) “Invest” the whole $1,000,000 on red or black at the roulette wheel.  (B) “Invest” on red or black $1000 at a time, one thousand times.

My friend said he knew the right answer, to that question and most of the others.  I believe he was offered this particular job, but declined it in lieu of better offers elsewhere.  Anyhow, he asked what my answer would be.

I said (B).  If single zero roulette, the client can expect to lose on 1/37 (about 2.7%);  if double zero, 2/38 or about 5.3%.   My friend said, sorry, wrong answer.  If you lose money for a high-net-worth client, even 2.7%, they are likely to be disappointed and take their business elsewhere.  If you double their money, a roughly 50/50 proposition, you will have an ecstatic client who will stick their $2,000,000 with you for years.  If you lose their whole $1,000,000 they will be disappointed and walk away, but “them’s the breaks.”

This story resonates with me to this day.  This is an absurd question from a financial standpoint, but it is a powerful question on ethics.  The business rationale behind answer (A) is valid.  However, I chose to work for a company where the correct answer is (B).

Since May 10th the Sigma1 Fund is down over 1000 dollars, closing today at $37,856.48.  I’ve been thinking about reducing the leverage of the fund from its current 1.57X to closer to 1.2X.  I have been weighing the cost of realizing some short-term capital gains versus a desire to deleverage.

On a separate note I’ve been bogging up a storm at my other other investing blog at Balhiser Investing.  There, I try to keep the topics less technical and more accessible to a wider investing audience.

* Sigma1 is a proprietary trading group fund, and is not currently available to outside investment.  It is currently structured as a long-short macro-centric hedge fund with long positions in equities (domestic and foreign) and junk bonds, and short positions in international bond ETFs.

I believe the US economy is finally, gradually, haltingly emerging from its drug-induced slumber.

So, what is my opinion on US equities?   Neutral to mildly bullish.

The fact of the matter is that US equities are leading economic indicators.  Unless you believe in momentum investing, which I don’t (see disclaimer), past market moments do not predict similar future market movements.  To the contrary, from a value investing standpoint, sharp upward market fluctuations simply presage undesirable valuations.  Or in plain English,  when the stock market skyrockets, be cautious.  That is why I’m not a fan of “plain English”;  it is too untextured, abstract,  and strangely foreign to my financial ear.

My opinion has very little to do with my asset allocation.  In painfully plain speak, “I pretty much stay the course with my investment choices, no matter how I feel at the time.”  In other words, I stick to a purposely pseudo-static asset allocation strategy with the empirically grounded assumption that impromptu reallocations increase standard deviations without increasing alpha.

I apologize for the last two sentences.

My opinion, for what it worth, is that I’m less certain about my bullish equity positions.  Simultaneously, I’m quite bearish on US debt securities… like US Treasuries (or as the WSJ writes it, Treasurys.)

All said, I am have not significantly changed the holdings of Sigma1.  Not yet.

Disclaimer:  Momentum investing is, in my opinion, only viable on a scale of seconds or microseconds in terms of algorithmic or “high frequency” trading.  In general it is a guise for other investment bets, some of which pay off and some of which do not.

This morning I realized that the Sigma1 Proprietary Trading Fund was allocated slightly dollar-centric rather than dollar-neutral.  To bring it back to USD-neutral I bought some BWX shares to cover a portion of my short positions.  Today the NAV of Sigma1 closed at $39,035.

As of this evening, the total NAV of the Sigma1 Proprietary Trading Fund is: $38,672.43, up over 10 percent from the original investment of $35,000.  Currently the Fund has no options positions and only long and short equity and EFT positions plus cash.

Note: Returns for outside investors would be lower after fees.  Currently the Sigma1 Fund is not available for outside investment.

Sigma1′s investing plans are hitting an inflection point.  On one hand, I’m very happy with Sigma1′s investment tack in the current economic environment.  On the other hand, I’ve been reading a lot of securities law and regulations, and finding a rigid framework that makes creative cost structures, well, virtually impossible.

In essence, I’m learning that many of the cost structures I’ve found undesirable in many funds (like sales loads) have been necessitated by the relatively immutable laws of economics and law.  There is a definite pressure from the confluence of economies of scale with the regulatory compliance costs biased towards larger funds.  The break-even point (in terms of AUM) for a fund is about 5-10X higher than my initial estimates.  I’ve been delighted with the low costs of proprietary trading, and frustrated with the regulatory and legal expenses of setting up a tradeable investment fund.

One thing is certain.  I’m going to keep on trading and investing.  Whether I put up the funds to take Sigma1 to the next level… that is more uncertain than late 2010.  But I’m still exploring options.  I’d love to make it happen.  It might take a long time, but I’ll make some tough decisions, and when I do, I’ll publish them here first.  Stay tuned.