White Paper Mechanical Investing Final 2014 …...White Paper Next-Generation Investment Strategy Marries Growth and Safety …Mechanical Investing Cuts Emotion from Decision-making…

White Paper

Next-Generat ion Investment St rategy

Marr ies Growth and Safety …Mechanical Investing Cuts Emotion from Decision-making…

Beacon Capital Management 323 Regency Ridge Drive Dayton, OH 45459 P: 866.439.9093 F: 937.424.4825 www.BeaconInvesting.com

White Paper Next-Generation Investment Strategy Marries Growth and Safety

www.BeaconInvesting.com © 2013 Beacon Capital Management. All Rights Reserved. 2

Execut i ve Summary

Even the most seasoned investors fall victim to emotional decision-making that can trigger

unwise or inefficient buy and sell moves. Portfolio performance often suffers, especially in

today’s rocky economic environment. Mechanical investing offers a viable approach to

avoiding significant losses and enhancing long-term returns.



Quant i ta t i ve Invest ing Super io r Approach to

Por t fo l io Management

Mechanical investing is a next-generation portfolio management strategy that allows for risk control

and eliminates emotion-led investment moves that plague even professional money managers and

often hamper or decimate portfolio performance.

Mechanical investing takes a hands-off approach, using in-depth analysis of markets as well as

computer-generated trading in order to enhance portfolio growth. Portfolios capitalize on market

efficiencies, but investments gain sizable levels of protection from the bumps and losses of today’s

roller coaster markets. Instead of the emotions of fear and greed entering into trading actions, the

computer automatically determines trade moves.

Actions Under Tight Scrutiny Those trade moves are based on a very specific set of proprietary parameters that are dictated and

fed into the computer system, says Chris Cook, president of Dayton, Ohio-based Beacon Capital

Management, and architect of Beacon Capital’s mechanical investing approach. One of those

parameters, for example, directs that when a portfolio’s value drops by 10 percent, equities are

automatically sold and replaced with fixed-income vehicles to protect the portfolio from serious losses.

“Our approach is 100 percent quantitative. We download new price information each day into our

computer system and the system tells us if any adjustments need to be made that day. We created

the formulas ahead of time, and follow the results without personal bias or emotions in the equation,”

he adds.

Decision-making Biases When it comes to investing, we as humans—professional investors or otherwise—are affected by fear

of monetary losses and even greed for gains. If you doubt that, consider how difficult it is to reach

your broker when the market tanks, because he or she is swamped with calls from other similarly

worried investors trying to get out of the market and cut their losses, or get in on the bottom floor in

anticipation of big gains.

Emotions enter the decisions of professional money managers, too, according to money manager and

advisor Robert Fischer.



“Investors and experts are prone to cognitive biases when making decisions, which frequently results

in misuse of information,” says Fischer. (“Let’s Get Naked: Why Individual Investors Should Shed the

Emperor’s Clothes of Wall Street Investment Experts,” Robert Fischer, ChangeThis.com, September 8,

2010).

Fischer points out a variety of cognitive biases, which range from “recency” (placing greater weight on

recently received facts) to “confirmation” (grasping at facts that support preconceived notions) to

“outcome bias” (judging the quality of a decision based on the final outcome as opposed to solid facts

and figures). All of these points lead an investor to make decisions using emotion rather than logic.

The Fallacy of Traditional Passive Investing Mechanical investing’s hands-off approach addresses these and other emotion-led weaknesses related

to market decisions. It is not, however, traditional “passive” investing. The passive mantra is that if

an investment is left alone, markets are efficient. Typical passive investments of choice are index-

based or rely on “buy-and-hold” as the safe haven against economic downturns.

Updated with Reality in Mind Instead, Beacon Capital’s mechanical investing strategy takes an updated approach to hands-off,

because a traditional passive investment strategy has a fatal flaw for many investors. Yes, markets go

up over time. But this happens over long periods of time, and few people today have the months and

years to wait for their investments to recover from precipitous drops that are characteristic of

markets, especially the bear market of recent years. Those drops decimate portfolios and can destroy

retirement security or other portfolio growth goals. That’s why Beacon Capital’s stop-loss strategy is a

parameter in its mechanical investing approach.

Loss Recovery an Arduous Process Recovery is not swift or assured amid the ups and downs of markets over time. Consider that a 37

percent loss similar to that of the S&P 500 in 2008 requires more than a 54 percent gain to recover.

Adding to portfolio recovery stress, from 1970 through 2009, the S&P’s largest one-year return was

37.58 percent in 1995 (see chart).



Source: “The Math of Gains and Losses,” Craig L. Israelsen, Ph.D., Brigham Young University, 2010.

Realistic Timelines The realities of market-recovery timelines and investor needs are taken into account with the

mechanical investing approach. “We use extensive analysis of market trends, mathematical

probabilities, patterns, and more to capitalize on market efficiencies so that portfolio goals become

achievable in realistic time frames no matter the state of markets,” says Cook.

Performance Options; Solid Returns The mechanical investing approach returns consistent gains that absorb potential market volatility and

perform well over time, whether a portfolio’s long-term goal calls for aggressive (higher risk),

balanced, or conservative (low risk/low growth) returns.

Consider the performance from 2003 to 2012 of a hypothetical $100,000 investment in a portfolio

utilizing a mechanical investment strategy and various-risk Vantage 2.0 products as compared with

the benchmark, Vanguard Standard and Poor’s 500. After ten years and without adjustments for

various investment goals—aggressive, balanced, and conservative—the S&P 500 benchmark

portfolio’s value was $193,603. That compares with the following performance utilizing the

mechanical investing approach:

• Vantage Aggressive 2.0: $280,581

• Vantage Balanced 2.0: $240,689

• Vantage Conservative 2.0: $195,599



Risk/Return Analysis

Source: Beacon Capital Management

Beyond High-Risk Strategies Beacon Capital’s mechanical investing strategy is not high risk like some other investment approaches

that utilize quantitative analysis or computer-generated trading maneuvers. Certain hedge funds, for

example, may base moves on “quant” strategies that involve quick mega buy/sell maneuvers with

highly volatile components.

Risk control is synonymous in mechanical investing, as is employing the best and most investor-

advantageous portfolio strategies combined with the science (as in mathematics and market

probabilities) of investing.

Selection of the particular investment product in turn takes into account one of three investor

risk/growth philosophies:

• Aggressive Portfolio: Low-income objective but with high long-term capital appreciation

and risk tolerance; seeks return mostly through higher-risk equities.

• Balanced Portfolio: For investors with moderate risk toleration and moderate growth and

income objectives; seeks to achieve above average capital appreciation over time in a mix

of equities and fixed income.

• Conservative Portfolio: For investors with high-income objective and low growth and risk

tolerance; focuses on “safer” fixed-income investments.



Seamless Realignment with Growth Needs Strategic portfolio flexibility is another advantage of Beacon Capital’s mechanical investing approach.

Even if markets cooperate and a traditional buy-and-hold approach is on track to achieve expected

portfolio gains within the forecast timeline, an investor’s situation and subsequent portfolio could

suddenly need to change because of divorce, looming retirement, a layoff, or some other major

expense. The buy-and-hold strategy does not offer the flexibility to shift gears without the specter of

significant losses.

Successful strategic portfolio management must include the ability to seamlessly realign when an

investor’s personal needs change. Mechanical investing offers that flexibility with its high-tech system

that can easily be redirected. As investor and portfolio needs change, so can computer-generated

strategies.



Conc lus ion

Mechanical investing is a quantitative and successful approach to portfolio management that

capitalizes on market efficiencies while offering investor flexibility and removing emotional

decision-making from the investment equation.

Beacon Capital Management employs a variety of investment strategies that are viable in the

current marketplace. For more information please call your advisor to schedule a

presentation.



Disc losures Disclosure for Backtested Performance Information on the BCM Model Portfolio Strategies: 1. Beacon Capital Management, Inc. (BCM) was incorporated in July 2000 and placed its first independent client investments in July 2000. The performance information presented in the chart or table represents backtested performance based on live (or actual) mutual fund results from July 8, 1987 to period ending date shown using the strategy. Backtested performance is hypothetical (it does not reflect trading in actual accounts) and is provided for informational purposes to indicate historical performance had the model portfolio strategies been available over the relevant period. BCM did not offer the model portfolio strategies until July 2000. Prior to July 2000, BCM did not manage client assets. Client portfolios are monitored and rebalanced, taking into consideration risk exposure consistency, transaction costs, and tax ramifications to maintain the investor objective of each model portfolio strategy. 2. A review of the Disclosure for BCM Sources and Description of Data is an integral part of and should be read in conjunction with this explanation of backtested performance information. 3. Backtested performance does not represent actual performance and should not be interpreted as an indication of such performance. Actual performance for client accounts may be materially lower than that of the model portfolio strategies. 4. Backtested performance results have certain inherent limitations. Such results do not represent the impact that material economic and market factors might have on an investment adviser's decision-making process if the adviser were actually managing client money. Backtested performance also differs from actual performance because it is achieved through the retroactive application of model portfolios (in this case, BCM’s model portfolio strategies) designed with the benefit of hindsight. As a result, the models theoretically may be changed from time to time to obtain more favorable performance results. 5. Backtested performance results assume the reinvestment of dividends and capital gains and rebalanced to maintain the investor objective. In reality, client’s accounts will be rebalanced either more or less frequently depending on the fluctuation of the mutual funds and the cash flow activity of the client. The performance of the BCM model portfolio strategies and satellite funds reflects and is net of the effect of BCM’s annual investment management fee of 1.8%, billed monthly. Depending on the size of your assets under management, your investment management fee may be less. Mutual fund fees and expenses have been deducted from results. Although the mutual funds BCM recommends attempt to minimize tax liabilities from short and long term capital gains, any resulting tax liability is not deducted from performance results. Performance results also do not reflect transaction fees and other expenses charged by broker-dealers and/or custodians, which reduce returns. BCM is not paid any brokerage commissions, sales loads, 12b1 fees, or any form of compensation from any mutual fund company or broker dealer. The only source of compensation from client investments is obtained from asset based advisory fees paid by the client. 6. For all data periods, annualized standard deviation is presented as an approximation by multiplying the monthly standard deviation number by the square root of twelve. Please note that the number computed from annual data may differ materially from this estimate. We have chosen this methodology because Morningstar uses the same method. 7. For all data periods, beta is a statistical measurement of volatility as compared to a benchmark. The Vanguard S&P 500 (VFINX) is used as the benchmark for comparison beta calculation.



8. For all data periods, alpha is a statistical measurement of excess return for risk borne as compared to a benchmark. The Vanguard S&P 500 (VFINX) is used as the benchmark for comparison alpha calculations. 9. Not all of BCM clients follow our recommendations and depending on unique and changing client and market situations we may customize the construction and implementation of the model portfolio strategies for particular clients, including the use of tax-managed mutual funds, tax-loss-harvesting techniques and rebalancing frequency and precision. The performance of custom asset allocations may differ materially from (and may be lower than) that of the model portfolio strategies. 10. Performance results for clients that invested in accordance with the model portfolio strategies will vary from the backtested performance provided due to market conditions and other factors, including investments cash flows, mutual fund allocations, frequency and precision of rebalancing, tax-management strategies, cash balances, lower than 1.8% advisory fees, varying custodian fees, and/or the timing of fee deductions. As the result of these and potentially other variances, our clients have not and are not expected to have achieved the exact results shown since July 2000, when we placed our first investment. Actual performance for client accounts may differ materially from (and may be lower than) that of the model portfolio strategies. 11. As with any investment strategy, there is potential for profit as well as the possibility of loss. BCM does not guarantee any minimum level of investment performance or the success of any model portfolio strategy or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. 12. Past performance does not guarantee future results. 13. DISCLAIMER: THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION PROVIDED HEREIN OR ON THE MATERIAL PROVIDED. This document does not constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services, except, where applicable, in states or countries where we are registered or where and exemption or exclusion from such registration exists. Any statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission thereof to the user. All investments involve risk, including foreign currency exchange rates, political risks, different methods of accounting and financial reporting, and foreign tax Disclosure for BCM Sources and Description of Data The following descriptions indicate how live (or actual) mutual fund results are strung together to simulate similar risk and return characteristics back to 1987. This reduces the standard error of the mean, which is unacceptably high for periods less than 20 years. Vantage 2.0 Model Portfolio Strategies There are three Vantage 2.0 Model Portfolio Strategies – Aggressive, Balanced, and Conservative. The key element of construction is the use of three primary portfolios that represent stocks, bonds, and cash. Each primary portfolio is comprised of mutual funds. The underlying mutual funds and allocations of the primary stock, bond, and cash portfolios is the same in all Vantage 2.0 Model Portfolio Strategies, only the allocation to the primary stock, bond, and/or cash portfolios changes to



meet the investor objective. The changes and timing of the allocation to the primary stock, bond, and/or cash portfolios are determined by a proprietary formula, which is constant throughout the time period measured. Vantage 2.0 Model Portfolio Strategies Primary Stock Portfolio October 2, 2004 – Present Vanguard Consumer Staples (VDC) 9.09% Vanguard Materials (VAW) 9.09% Vanguard Financials (VFH) 9.09% Vanguard Health Care (VHT) 9.09% Vanguard Energy (VDE) 9.09% Vanguard Information Technology (VGT) 9.09% Vanguard Utilities (VPU) 9.09% Vanguard Consumer Discretionary (VCR) 9.09% Vanguard Industrials (VIS) 9.09% Vanguard REIT (VNQ) 9.09% Vanguard Telecommunications (VOX) 9.09% July 1, 2000 - September 30, 2004 Consumer Staples Select SPDR (XLP) 9.09% Materials Select SPDR (XLB) 9.09% Financial Select SPDR (XLF) 9.09% Health Care Select SPDR (XLV) 9.09% Energy Select SPDR (XLE) 9.09% Technology Select SPDR (XLK) 9.09% Utilities Select SPDR (XLU) 9.09% Consumer Discretionary Select SPDR (XLY) 9.09% Industrial Select SPDR (XLI) 9.09% iShares Dow Jones US Real Estate (IYR) 9.09% Fidelity Select Telecommunications (FSTCX) 9.09% January 1, 1999 - June 30, 2000 Consumer Staples Select SPDR (XLP) 9.09% Materials Select SPDR (XLB) 9.09% Financial Select SPDR (XLF) 9.09% Health Care Select SPDR (XLV) 9.09% Energy Select SPDR (XLE) 9.09% Technology Select SPDR (XLK) 9.09% Utilities Select SPDR (XLU) 9.09% Consumer Discretionary Select SPDR (XLY) 9.09% Industrial Select SPDR (XLI) 9.09% Fidelity Real Estate Investment (FRESX) 9.09% Fidelity Select Telecommunications (FSTCX) 9.09% March 24, 1993 - December 31, 1998 Fidelity Select Consumer Staples (FDFAX) 9.09% Fidelity Select Materials (FSDPX) 9.09% Fidelity Select Financial Services (FIDSX) 9.09% Fidelity Select Health Care (FSPHX) 9.09%



Fidelity Select Energy (FSENX) 9.09% Fidelity Select Technology (FSPTX) 9.09% Fidelity Select Utilities (FSUTX) 9.09% Fidelity Select Consumer Discretionary (FSCPX) 9.09% Fidelity Select Industrial Equipment (FSCGX) 9.09% Fidelity Real Estate Investment (FRESX) 9.09% Fidelity Select Telecommunications (FSTCX) 9.09% June 21, 1990 - March 23, 1993 Fidelity Select Consumer Staples (FDFAX) 10.00% Fidelity Select Materials (FSDPX) 10.00% Fidelity Select Financial Services (FIDSX) 10.00% Fidelity Select Health Care (FSPHX) 10.00% Fidelity Select Energy (FSENX) 10.00% Fidelity Select Technology (FSPTX) 10.00% Fidelity Select Utilities (FSUTX) 10.00% Fidelity Select Industrial Equipment (FSCGX) 10.00% Fidelity Real Estate Investment (FRESX) 10.00% Fidelity Select Telecommunications (FSTCX) 10.00% April 18, 1998 - June 20, 1990 Fidelity Select Consumer Staples (FDFAX) 11.11% Fidelity Select Materials (FSDPX) 11.11% Fidelity Select Financial Services (FIDSX) 11.11% Fidelity Select Health Care (FSPHX) 11.11% Fidelity Select Energy (FSENX) 11.11% Fidelity Select Technology (FSPTX) 11.11% Fidelity Select Utilities (FSUTX) 11.11% Fidelity Select Industrial Equipment (FSCGX) 11.11% Fidelity Select Telecommunications (FSTCX) 11.11% July 8, 1987 - April 17, 1988 Fidelity Select Consumer Staples (FDFAX) 12.50% Fidelity Select Materials (FSDPX) 12.50% Fidelity Select Financial Services (FIDSX) 12.50% Fidelity Select Health Care (FSPHX) 12.50% Fidelity Select Energy (FSENX) 12.50% Fidelity Select Technology (FSPTX) 12.50% Fidelity Select Utilities (FSUTX) 12.50% Fidelity Select Telecommunications (FSTCX) 12.50% Vantage 2.0 Model Portfolio Strategies Primary Bond Portfolio April 10, 2007 - Present Vanguard Long Term Bond (BLV) 33.33% Vanguard Intermediate Term Bond (BIV) 33.33% Vanguard Short Term Bond (BSV) 33.34% June 20, 1996 - April 9, 2007



Vanguard Long Term Bond (VBLTX) 33.33% Vanguard Intermediate Term Bond (VBIIX) 33.33% Vanguard Short Term Bond (VBISX) 33.34% June 4, 1990 - June 19, 1996 Vanguard Total Bond Market (VBMFX) 100.00% June 15, 1989 - June 3, 1990 Fidelity Intermediate Bond (FTHRX) 100.00% July 8, 1987 - June 14, 1989 Fidelity GNMA (FGMNX) 100.00% Vantage 2.0 Model Portfolio Strategies Primary Cash Portfolio July 1987 - Present 0.00% Return Cash Position 100.00% Disclosure for Benchmark Portfolio 1. Benchmarks provide the standards against which investment performance is measured. Benchmarks are typically a combination of specific indexes that are representative of specific asset classes. Industry accepted indexes are available for virtually all traditional asset class - stocks, bonds, and cash. Such is not the case for alternative asset classes, where benchmarks are not available - commodities and currencies. You cannot invest directly in a index. 2. Benchmark performance results assume the reinvestment of dividends and capital gains and rebalanced to maintain the investor objective. No management fees have been deducted from the performance of the benchmark. Mutual fund fees and expenses have been deducted from results. 3. For all data periods, beta is a statistical measurement of volatility as compared to a benchmark. The Vanguard 500 Fund (VFINX) is used as the benchmark for comparison beta calculations. 4. For all data periods, alpha is a statistical measurement of excess return for risk borne as compared to a benchmark. The Vanguard 500 Fund (VFINX) is used as the benchmark for comparison alpha calculations. 5. A benchmark is created for each portfolio based on the selection and allocation of Beacon model portfolio strategies and/or satellite funds. Funds considered to be alternative asset classes are allocated to stocks. The following descriptions indicate how index results are strung together to simulate benchmark risk and return characteristics back to 1987. Stocks July 8, 1987 – Present Vanguard 500 (VFINX) 100.00%



Bonds June 4, 1990 - Present Vanguard Total Bond Market (VBMFX) 100.00% June 15, 1989 - June 3, 1990 Fidelity Intermediate Bond Fund (FTHRX) 100.00% July 8, 1987 - June 14, 1989 Fidelity GNMA Fund (FGMNX) 100.00% Money Market July 8, 1987 - Present 0.00% Return Cash Position 100.00%

Documents

White Paper Mechanical Investing Final 2014 …...White Paper Next-Generation Investment Strategy Marries Growth and Safety …Mechanical Investing Cuts Emotion from Decision-making…