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FAQsWhat is SweetSpot’s investment approach? What does SweetSpot’s track record look like? If this is such a good way to invest, why isn’t everyone using your strategy? How do you know when a sector’s sweet spot is reached? Besides SweetSpot’s track record, are there studies that support this approach? Why doesn’t conventional investment methodology work as well as your approach? How risky is SweetSpot compared with the broader market? Is SweetSpot a value approach a la Warren Buffett? How long have you been trading SweetSpot for which you can provide verifiable account records? How liquid are SweetSpot holdings? What is the typical turnover rate of the SweetSpot Portfolio? What are your fees and account minimums? Can you tell us a little bit about your background? How does a new SweetSpot investor get started?
Q: What is SweetSpot’s investment approach? A: By employing complementary “long” and “short” investment strategies, SweetSpot Hedged seeks to moderate stock-market risk without sacrificing returns. The long side of the program invests in out-of-favor global market sectors, a strategy that has consistently outperformed the broad market over time. The short side relies on a time-tested methodology for anticipating extended market declines, allowing us to avoid the worst losses the market can dish out. We remain invested in the long side at all times, and we sell the broad market during periods when its prospects are bleak. The two strategies work together to produce a historically high-return, low-risk, diversified portfolio. We invest in the stock market’s most unpopular areas — the ones investors have essentially abandoned. Although this approach may seem counter-intuitive, it has worked very well over time: Since SweetSpot’s inception in 1999, each year’s picks have always collectively beaten their market benchmark during the period they were held. Methodology
“SweetSpot® investing” begins with a universe of about 500 non-diversified mutual funds and ETFs, broken down into almost 100 “sectors” (industry groups or international regions). Each year we collect the data that will enable us to rank the sectors according to how popular they are with investors. Our proprietary formula evaluates things like cash flows, net assets, and price performance for every fund in our universe, which we then compile for each sector. Once the sector rankings are complete, we target for purchase the highest-ranked sectors — or lowest-ranked by the investing public — in a three-year hold. The resulting portfolio is well-diversified, giving us an ownership interest in over 2,000 companies, both foreign and domestic.
In an effort to isolate SweetSpot’s performance from that of the broad stock market — and in the process sharply reduce our exposure to market risk – SweetSpot converted to a long/short program in 2009. We remain invested in SweetSpot at all times, but we sell (or “short”) market-index funds, futures contracts, or both whenever the broad market seems to be at risk of an extended decline. We make this determination based on research showing we can insure ourselves against the worst losses the market can dish out, without giving up much, if any, of the market’s upside. Our specific methodology directs us to hedge whenever the market’s intermediate-term trend falls below its long term trend. That’s when virtually every extended market decline in history began. We remove the short position when the intermediate-term trend rises back above the long-term. Q: Why do you hedge the market?? A: Not to answer a question with a question, but why do you buy car insurance? Or health insurance? You may live your whole life and never crash your car or become seriously ill. Yet future stock-market declines are a given, and the worst of them can be as devastating as any calamity. Not knowing what the future holds, we are left to position ourselves for whatever comes, good or bad. In an uncertain world, “portfolio insurance” is a must. Amidst all of this uncertainty, one thing seems likely: that SweetSpot will outperform the market in the future as it has in the past. Maybe not every month or even every year, but over time. Performance over time is what we care about. Of course, no matter how well something has worked in the past, we have no assurance it will perform as well in the future. Accordingly, we hedge. A: In stock investing, the term “sweet spot” refers to that point in a market cycle where a downward trend begins to level off, and potential rewards now outweigh potential risks. At the sweet spot, the market is saying something like, “Things can’t get any worse and they’ll never get any better” – which is kind of silly if you think about it. Even if more bad news does come out, the worst has already been factored into the price so nothing much happens. But if the news is unexpectedly good, the trend reverses upward and a new market cycle is born.  Click On Image to Enlarge Q: What does SweetSpot’s track record look like? A: In the ten-year period from December 31, 1999 through December 31, 2009, a dollar invested in SweetSpot Unhedged grew to $3.52, while that same dollar invested in the S&P 500 actually shrank to 97 cents. On average, SweetSpot returned 10 points better per year than the S&P 500. Perhaps most significantly, positions bought each year have always collectively outperformed their market benchmark during the period they were held. When we combine SweetSpot’s real-time returns with a hedging strategy, a dollar would have grown to $6.43 (after fees), almost a 20% net annualized return. During the worst of the 2000-2003 bear market, market-hedged portfolios not only protected capital but continued to compound returns at high levels. During the 2007-2009 sell-off, SweetSpot Hedged would have suffered little downside.
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Note that the performance figures for SweetSpot Hedged represent the returns that would have resulted from trading a short strategy alongside SweetSpot’s real-time long program. It was assumed that short trades were entered in an amount equal to the value of the long portfolio as of the trade date, and earned the inverse of the S&P 500 Index. There is nothing hypothetical about SweetSpot’s real-time track record, however: Since inception in December 1998, the only calendar year that SweetSpot Unhedged underperformed its market benchmark was 2006. But there is no stock-investment strategy that has been shown to beat the market every year. If anything, 2006 demonstrated that year-over-year returns are not relevant to our long-term prospects: At the end of that “subpar” year we completed the most successful three-year trade in SweetSpot’s history.
Q: If this is such a good way to invest, why isn’t everyone using your strategy? A: As a true contrarian strategy, SweetSpot by its very nature is unlikely to catch on — which is all the better for investors who are able to perceive its value. Q: You invest in sectors — why? A: Sectors are uniquely well suited to an approach that relies on market cycles. When we break down the investment universe into its component parts, we find that each sector is moving within its own market cycle – going strong, going bust, or going nowhere. We work with a sizable universe; there are always sectors that are out of favor with investors and, of those, some are likely to be at or near a bottom.
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With a sector approach we end up with a nicely diversified basket of funds that spreads the risk around. We also sidestep the company-specific risks associated with individual stocks. It’s odd that so many investors who would not consider investing in supposedly risky sectors won’t hesitate to buy a stock if they like its “story.” Individual stocks are much riskier than sectors.
 Q: How do you know when a sector’s sweet spot is reached? A: Well, we can’t say we know when the sweet spot is reached – wouldn’t that be great? In fact, only in hindsight can the sweet spot be identified conclusively. But SweetSpot is about probabilities. The SweetSpot formula looks at sector-specific data – that is, numbers – but what it really measures is human behavior. The best evidence of investor sentiment is the movement of capital into some sectors and out of others. But we have to be careful — although market bottoms are usually characterized by extreme capital outflows, it does not follow that such outflows only occur at market bottoms. Still, on the rare occasions when we have bought a sector that was far from its bottom, we actually benefited from the opportunity to add cheaper shares. That’s why it usually pays to keep a certain percentage of assets in cash. Even without averaging down our cost basis, however, SweetSpot’s track record shows that a three-year holding period has been enough time for our investments to recover their value and ultimately show market-beating profits. Q: Besides SweetSpot’s track record, are there studies that support this approach?
A: Several studies by different investment research firms provide support for SweetSpot’s specific methodology, and many others over the years support SweetSpot’s basic premise – that contrarian investing works. It’s an age-old truism: “When everyone thinks alike, everyone is likely to be wrong.” But for most investors, being a contrarian is easier said than done. As Warren Buffett has said, “It’s simple but it’s not easy.” One of SweetSpot’s big advantages is that we are essentially forced to take a contrary position. Mr. Buffet’s mentor Benjamin Graham once said that in order to be a successful investor, “People don’t need extraordinary insight or intelligence. What they need most is the character to adopt simple rules and stick to them.” SweetSpot gives us simple rules that are worth adopting and sticking to. In 2006, after SweetSpot had registered seven straight years of solid performance, we ran a back test to see how the strategy would have performed historically. We found market-beating returns going back to 1989,* which is the earliest it would have been possible to trade this type of strategy. We can also find plenty of support for SweetSpot in behavioral finance, which has shown that our brains react the same way to certain stimuli. When everyone around us is selling, our irrational “caveman” brain tends to take over. Investment opportunities must exist if just about everyone is taking the same action based on emotion and not objective analysis. Q: Why doesn’t conventional investment methodology work as well as your approach? A: It all comes down to price. Most investors buy stock in companies that are known to have good growth prospects. If the growth comes, fine – maybe the stock will continue to appreciate. But there’s no margin for error – if bad news comes, the price will suffer and investors will sell. This dynamic serves to perpetuate the “buy-high, sell-low” cycle that plagues most investors. SweetSpot investors, in contrast, buy sectors that have a negative story attached to them, so at least we know we’re buying low (even if not at the low). And so far, we have completed almost every trade by selling high. Q: How risky is SweetSpot compared with the broader market? A: Even without hedging, SweetSpot’s historical risk-adjusted returns have been outstanding. From 1999 until 2009, every completed SweetSpot trade was profitable, as we beat the market by a wide margin. While SweetSpot has continued to outperform its benchmark, our string of profitable trades came to an end in 2009. Moreover, simply beating the market wasn’t enough to protect us from unacceptably poor absolute returns in 2008. Few investors are willing to leave themselves vulnerable to the kind of wealth destruction we saw in 2008 and could see again. To stay in the game, an adjustment was necessary, and we found the one we wanted to make. The Short Side SweetSpot’s risk profile was transformed in 2009 when the program was converted to SweetSpot Hedged. The long side of the program is unchanged; we will continue to buy beat-up sectors each year and hold them for at least three years. The short side consists of selectively selling the broad stock market according to a backtested strategy that looks at some of the same measures we use to inform our SweetSpot trades. This approach can be expected to improve SweetSpot’s already-low risk profile relative to the market.
The Long Side SweetSpot is a “deep-value” approach to investing, meaning that much of the risk we would otherwise face was already suffered by those who held our positions before we acquired them. Moreover, investors who have sold out of the oversold sectors we’re about to buy cannot then sell them after we buy. Selling pressure is what drives stock prices lower, so it’s comforting to know that the number of prospective sellers who could move prices against us is depleted. It is true that individual sectors can be more volatile, or “riskier” than the market as a whole. But what if you hold a basket of a dozen or more sector funds, spread across a broad range of industries and international regions? The day-to-day gyrations of any individual fund in that basket become irrelevant. The changes in value of the whole basket are what we care about. And those changes tend to resemble the market’s movements, the only difference being a noticeable tendency to appreciate a bit more on up days and lose a bit less (or even gain) on down days. SweetSpot investing is similar to buy-and-hold but with a twist: Every year we sell the positions that have had ample time to realize their full value, and then we “refresh” our holdings with new positions that have years of value recovery ahead of them. Conservative investors want to limit unnecessary trading; SweetSpot has shown that frequent trading is not required to achieve solid returns. Q: Is SweetSpot a value approach a la Warren Buffett? A: SweetSpot actually reflects more closely the way Warren Buffett used to invest, by looking for solid companies whose stock was priced below their break-up value. SweetSpot sectors tend to include many stocks that meet this standard or come close. Mr. Buffett learned this approach from Benjamin Graham, who developed it during the depression era when dirt-cheap companies were plentiful. When that changed, Mr. Buffett went from trying to buy good companies at a great price, to buying great companies at a good price. Q: How long have you been trading SweetSpot for which you can provide verifiable account records? A: We have records going back to SweetSpot’s inception in December 1998. Q: How liquid are SweetSpot holdings? A: Very. Mutual funds can be sold any day the market is open, and the trades usually settle the next day. ETFs trade like stocks, so they can be sold throughout the trading day. The proceeds can be used for some purposes immediately upon execution of a trade, and settlement occurs three days later. Q: What is the typical turnover rate of the SweetSpot Portfolio? A: Average annual turnover is about 25%, and all SweetSpot trades qualify for long-term capital-gains tax treatment. Normally, entering three-year trades once a year would give us a 33% turnover rate, but every now and then a position we already hold becomes a repeat trade and we restart the three-year clock at that point. This effectively lowers overall turnover. Q: Is your approach proprietary? A: Our formula is proprietary, and we know of no other source for the information one would need to trade this approach. There is also no single mutual fund or ETF we know of that offers anything resembling SweetSpot. Indeed, you’re unlikely to hear about this style of investing from money managers who feel they have to justify their fees by showing that they are “actively” managing your investments. Yet trading for its own sake is counter-productive and investor-unfriendly. Q: What are your fees and account minimums? A: Our current new-account minimum is $100,000. Annual fees, paid quarterly, are 1.5% of assets under management. Q: Where are accounts domiciled?
A: The custodian for most SweetSpot accounts is Fidelity Investments, but accounts can be at any firm that offers investors access to markets for mutual funds, exchange-traded funds, or both. Note, however, that IRAs and other restricted “cash” accounts can pose a challenge for hedging strategies that rely on margin. One way to meet this challenge is to establish a “futures IRA” at a firm such as thinkorswim. Another is to pair a restricted account with a taxable margin account to be used for hedging purposes. Clients who lack these options (for example, if a restricted 401(k) account holds most of a client’s investable assets) typically will sell some portion of their stock holdings when we get a sell signal on the market. We are happy to work with clients to find the best solution for their individual circumstances. Q: Can you tell us a little bit about your background? A: I am a Phi Beta Kappa graduate of Michigan State University, and I earned a law degree from The George Washington University Law School. That was followed by a successful legal career in both the public and private sectors. I specialized in environmental law, having authored two books on the subject. For over 25 years I have also been a student of investing. A few years into my legal career, after I had paid off my student loans and actually accumulated some capital, I realized I was responsible for my own financial well being. Yet in all my years of schooling, I was never taught how to invest. It took lots of hard work and trial and error to learn for myself what works and what doesn’t in the investment arena. SweetSpot brought it all together, and the decision to base a business on it essentially made itself. In 2007, I founded SweetSpot Investments LLC and registered as an investment adviser in the State of Michigan. Q: How does a new SweetSpot investor get started? A: New SweetSpot investors should take the following steps:
For assistance, or to receive periodic updates on performance, call 248-254-6648 or email info@sweetspotinvestments.com. *Backtesting suffers from certain inherent limitations. In particular, the backtested results for SweetSpot’s hedging strategy do not represent actual trading; they may not reflect the impact that material economic and market factors may have had on an adviser’s decision-making if the adviser were actually managing clients’ money. Maybe that’s why so many strategies fall short when investors attempt to duplicate backtested results. Contrast the hedge backtest, however, with the 2006 backtest of SweetSpot’s long strategy. While that backtest showed a clear advantage over the market, SweetSpot’s real-time results since 1999 far exceeded what the backtest would have predicted. The backtest merely confirmed that the strategy would have worked over a longer time horizon than the period in which it has been actively traded. Still, no representation is made that investors will see profits similar to either actual or hypothetical past results. Disclaimer: SweetSpot Investments LLC is a registered investment adviser in the State of Michigan, USA, and is authorized to do business under various exemptions in other States and foreign Nations. The firm will not solicit or accept business in any jurisdiction in which it is not properly qualified to conduct business.
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