Mader & Shannon Wealth Management:

George Shannon, Chief Investment Strategist and Portfolio Manager

Research and Analysis Methods:Philosophy, Daily Routine, and Strategy

Overview:

This outline is designed to introduce new clients and potential clients to both the investment philosophy and practical daily routine of the Portfolio Management division of Mader Shannon Wealth Management.  As the Chief Investment Strategist and Portfolio Manager it is my responsibility on a daily basis to digest relevant researched economic, financial, and market information of various types and from diverse sources both to protect our clients capital and to achieve very competitive investment results. 

Experience:

Our approach to investing and our appreciation of the role the market itself plays in investment results is based on my 30 years of experience as an investment advisor in the securities industry.

My career started in 1974 as trainee at Merrill Lynch in New York and then a stockbroker for Merrill Lynch in Houston,  I received management training at Payne Webber, (now known as UBS) and worked as a Producing Branch Manager at Payne Webber, A.G. Edwards and Southwest Securities.

I have been doing economic commentary since Graduate school, writing articles for the Daily Texan and providing a morning market report for Austin Radio Station KVET, then appearing on television and radio in Texas. Currently I am an occasional guest columnist on market issues for the Kansas City Star. (Click Here to See Recent Kansas City Star Article - Use Back Arrow to Return to This Outline)

Philosophy:

Having managed money for thirty years, and having experienced both both bull and bear markets in periods of both overvaluation and undervaluation, I believe that active money management is the most effective, responsible way to manage clients funds.   As a supporter of the Graham-Dodd approach to determining value, I believe the present value of expected future cash flows is the standard for valuation.Three academic articles that underpin our philosophy are Valuation Ratios and the Long-Run Stock Market Outlook: An Update" by John Y. Campbell and Robert J. Shiller" Stock Market Returns in the Long Run" by Roger G. Ibbotson and Peng Chen: and "From Efficient Markets Theory to Behavior Finance" by Robert J. Shiller.

My goal for the average equity client is to out perform of the S&P 500 through skill. Since Jim Mader and I formed Mader & Shannon and I took on the role as Chief Investment Strategist and Portfolio Manager, our consolidated performance has exceeded this goal. This ability is all too rare (as many studies have demonstrated), making it all the more impressive that we have been able to accomplish this since our inception. Although past performance is no assurance of future results, studies have also shown that one of the best indicators of a manager who will outperform the S&P in the future is his past performance. Mader & Shannon is proud to have consistently beaten the S&P in its past performance.

One important area of understanding I think central to success is an appreciation of  the dynamics of the overall market environment: acknowledging both the positive and negative power of momentum, and respecting the concept of a “crowded” trade, and knowing that the "market" can both over-value and under-value individual stocks and entire sectors for extended periods of time.

I believe it is important to understand that the market itself creates a demand. Forces within it can materially affect demand for certain groups or types of stocks. For example, the current use of Exchange Traded Funds (ETFs) creates a demand for stocks people may not have normally been interested in buying.

My investment decisions draw on the experience of having made investment decisions in all types of market environments for over 30 years, and are based on sound fundamental independent research of the investment and the role it plays in the market environment.

Accurate and descriptive measurement of our progress in order to illustrate our performance in as many ways as possible to show our clients how their portfolios are doing.

Concentrate on both our overall performance as well on individual client portfolios.

Daily Routine:

 -Begin the day at 3am to check foreign markets using CNBC and internet.

 -Evaluate U.S. markets using CNBC starting at 5 am.

 -Assistant in by 7am.

 -Run reports to compile results from the previous day’s market.

 -Set up a spreadsheet to track our progress through the day.

 -View a three-dimensional map of the market to visualize the strength of individual stocks and sectors.

Research Materials:

 -S&P Reports (looking for S&P Ratings and recommendations, as well as News on individual stocks)

 -Zacks Investment Research (We receive daily updates of all positions by 4 a.m., including changes in earnings estimates and analysts upgrades or downgrades).

 -Value-Line Investment Research.

 -McDep Independent Energy Valuation. The McDep ratio stands for Market Cap and Debt to present value of energy businesses. McDep’s website gives a weekly analysis of energy income stocks in the U.S. and Canada. 

Analytical Tools:

 -Vector Vest Graphs: updated by after each market session: provides technical outlook for current and prospective holdings, as well as updates widely followed indexes such as the CPI and Fed Funds Rates. They illustrate the performance of individual stocks, indices, and sectors. A typical graph will go back 5 years.

 -Updatable spreadsheet. This allows us to have on hand a watch list of all the positions we own, the value of each position relative to our total holdings, and an up-to-the-minute quote for each stock.

 -Advent Axys Reports. Advent Axys is the software we use to manage all our accounts and positions. Advent allows us to run a plethora of reports depending on the data we are searching for. For example, we can see what percentage of each type of holding each client owns.

 -Map of the Market. This tool gives us a three-dimensional illustration of our positions as well as the market as a whole.

Descriptive Statistics:

 -Alpha and Beta. As of 7/31/2008, our Alpha is 3.183, and our Beta is .7495. We are achieving our goal is to have a Beta below 1 and a high alpha.

   Beta describes how the expected return of our portfolio correlates to    the return of the S&P 500. A portfolio with a beta of 0 means that its    price is not at all correlated with the market and is independent. A    positive beta means that the asset generally follows the market. A    beta higher than 1 means that the portfolio is more volatile than the    benchmark and involves a higher risk.

   Alpha is a common measure for assessing an active manager’s    performance as it is in excess of a benchmark index, in our case the    S&P 500. It is based on our Beta score. In other words, it is shows    how our performance exceeds the S&P’s, taking risk into account.

 -Time Weighted Rate of Return: This figure is our rate of return for a given period but it is adjusted to take into account when funds were received. For example, the TWRR will be higher than our internal rate of return if funds were received at the top of the market. The time weighted rate of return, then, is a more accurate illustration of the manager’s performance.

 -Value-Added: This figure compares our rate of return (either time weighted or actual) to the S&P 500’s rate of return for a given time period. It shows by how many percentage points we outperformed the S&P 500’s return for a give time period.

 -Percent Cash: This figure show what percentage of our total value was help in cash at any particular time. The change in this figure from month to month illustrates how our portfolio management style involves constant adjustment of holdings in reaction to the market, and it shows how we adjust our level of conservatism depending on the performance of the market at any given time.

Strategy:

 -We look for High Dividend, High Yield, High Quality stocks, approved by the S&P.

 -Our choices are based on a combination of experience of how to analyze present value (which tells us if we think a stock is overvalued) and analysis of hard numbers which show how a stock is perceived by the market.

 -Factors we take into account when analyzing present value and the value of future cash flows are the expected interest rate and the rate of inflation.

 -If a stock is in an Exchange Traded Fund (ETF), there will be additional movement surrounding it. Therefore, we are more likely to buy stocks that are in ETFs.

 -Keep in mind the Modigliani Theorem that a rational executive will use internal funds (instead of paying a dividend) only to the extent that can get a rate of return higher for his shareholder than the going interest rate. In other words, it makes not difference if a stock pays interest rates or not because it is maximize returns for the shareholder either way. The reason that we often look for stocks with high dividends, however, is that in the real world executives are not always as rational as they are in theory.

 -It’s true that investing in the company instead of paying dividends is good for growth, however, it ignores the need for current cash flow of investors, which is another reason we look for stocks with high dividends.

 -The stock of a company with debt is fine. Debt is often needed for expansion, as long as the rate paid on bonds is lower than the interest rates paid on outstanding loans.