Counterpoint Tactical Income and Tactical Equity Fund September 2017 Update
Counterpoint Tactical Income
The Fund remains invested in a risk-on posture, positioned in high-yield corporate bonds. Our assessment of the high yield credit market remains as it has for much of the past year: Fundamental drivers suggest continued short-term positives, while tail risks remain a concern.
Crude oil’s rise from the early 2016 lows and recent range-bound trading from the mid-$40s to mid-$50s has signaled a friendlier environment for high yield credit. Stable and bullish oil prices are supportive for high yield borrowers in the energy sector, and healthy demand for industrial commodities such as copper is an indicator of continued economic growth. Both of these narratives contribute to a positive fundamental outlook for high yield.
Meanwhile, high yield credit spreads are near 5 year lows, with the Bloomberg Barclays US Corporate High Yield Average option-adjusted spread at 3.64%. As we mentioned in last month’s update, low (but not extremely low) credit spread environments have historically presented attractive short-term opportunities in high yield. In this case, the current yield spread suggests less than a 30% chance of triggering a stop in our tactical high yield system in the following four months.
Meanwhile, expectations are for the Fed to leave the Fed Funds rate unchanged in its upcoming September meeting while it continues to pare back its balance sheet of longer-duration assets. This decision is consistent with the established trend – a modest yet fragile macroeconomic outlook. From September 8th to September 15th, five year U.S. Treasury yields have bounced approximately 23 basis points (from 1.6% to 1.83%). This reflects both receded fears around geopolitical risks in North Korea as well as a justifiably more hawkish Federal Reserve in the face of a resilient continued bull market in stocks.
On the negative side, hurricanes hitting U.S. shores call to mind that a low-probability but highly disruptive event could interrupt the existing trend. The extreme rise in cryptocurrency prices and continued all-time highs in stocks as represented by the S&P 500 index further suggest that speculation is driving some of the price action in riskier assets.
While it is important to assess the factors affecting the Fund’s holdings, we continue to rely on our quantitative trend-following strategy when determining our risk-on or risk-off posture. We remain committed to Tactical Income’s primary objective: earning a reasonable return on risky assets while avoiding drawdowns.
Counterpoint Tactical Equity
Counterpoint Tactical Equity remains in a risk-on posture, targeting an 80% to 85% exposure to the S&P 500 index. In recent months, the Fund has benefited from strong underlying factor performance in its market-neutral portfolio.
Quarter-to-date factor performance in categories of analyst expectations, earnings quality, and momentum have all been supportive with regards to Counterpoint Tactical Equity’s positioning. Valuation factors in Asia have been aligned with long term performance, while across the globe, higher volatility stocks have recently outperformed relative to their lower risk counterparts. This reversion in volatility is an adverse move for investors who take the academically-backed bet to invest in lower risk stocks to capture long-term outperformance.
A summary of global returns from several individual factor styles, some of which Tactical Equity uses in its stock selection, are provided by S&P Capital IQ. Categories for which positive performance is good are highlighted in green. Investors who buy the most volatile stocks typically underperform in the long-run, so this factor is highlighted in red.
Counterpoint re-positioned the Fund to target sector neutrality at the end of the 2nd quarter. This change sought to reduce risk to specific industries within the stock market, and has helped to steady the fund’s risk profile. We have also reached full implementation of an international portfolio strategy whose goal is to capture additional alpha opportunities as well as create further diversification benefits. The Counterpoint Tactical Equity Fund is now roughly weighted towards 50% long-short exposure in its US market neutral portfolio, and 70% of long-short exposure in its ex-US segment.
Return Spread is the difference between the top quintile and bottom quintile returns, seeking to eliminate the broad market return to show performance on a factor. Size is a blend of returns to market capitalization and total revenues. Top quintile represents highest market capitalization and revenues. Volatility is blend of factors to total standard deviation in annual and recent month periods as well as beta to the broad market. Top quintile represents highest volatility stocks. Analyst Expectations represents factors such as realized earnings surprise versus expectations measures, and estimate diffusion (the net change in analyst expectations of earnings results). Top quintile represents the blend of signals that signify positive developments for companies relative to baseline expectation. Historical Growth represents a blend of factors including 1 year changes in cash flow and earnings per share. Top quintile represents those companies which have historically exhibited the highest growth rates. Price Momentum is a combination of momentum factors (i.e. recent 12 month return, five day returns, nine month returns). Top quintile represents stocks that have had the best recent price performance. Earnings Quality represents measures that describe the quality of earnings including net profit margin and stability of net income. Top quintile represents stocks which excel in these measures. Capital Efficiency refers to a firm’s ability to deliver excess returns relative to its cost of capital. It includes a blend of ratios such as return on equity, return on invested capital, and share issuance. Top quintile signifies companies that excel in these measures relative to the rest of the market. Valuation factors are variety of metrics some as book to market, earnings to price, sales to price, and cashflow to price. Top quintile represents stocks which excel in these measures. The The BofA Merrill Lynch Option-Adjusted Spreads (OASs) are the calculated spreads between a computed OAS index of all bonds in a given rating category and a spot Treasury curve. An OAS index is constructed using each constituent bond’s OAS, weighted by market capitalization. The BofA Merrill Lynch High Yield Master II OAS uses an index of bonds that are below investment grade (those rated BB or below). The referenced indices are shown for general market comparisons and are not meant to represent the Fund. Investors cannot directly invest in an index; unmanaged index returns do not reflect any fees, expenses or sales charges.
The Bloomberg Barclays US Corporate High Yield Average Option-Adjusted Spreads (OAS) are the calculated spreads between a computed OAS index of all bonds in a given rating category and a spot Treasury curve. An OAS index is constructed using each constituent bond’s OAS, weighted by market capitalization. The Bloomberg Barclays US Corporate High Yield Average OAS uses an index of bonds that are below investment grade (those rated BB or below).
There is no assurance the Fund Advisor’s opinions of risk management will come to pass and past performance is no assurance of future results. Of course, there is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses. Mutual Funds involve risk including the possible loss of principal. The use of leverage by the Fund or an Underlying Fund, such as borrowing money to purchase securities or the use of derivatives, will indirectly cause the Fund to incur additional expenses and magnify the Fund’s gains or losses. Derivative instruments involve risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional investments. There is a risk that issuers and counterparties will not make payments on securities and other investments held by the Fund, resulting in losses to the Fund.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Counterpoint Tactical Income Fund. This and other important information about the Fund is contained in the prospectus, which can be obtained at www.counterpointmutualfunds.com or by calling 844-273-8637. The prospectus should be read carefully before investing. The Counterpoint Tactical Income Fund is distributed by Northern Lights Distributors, LLC member FINRA/SIPC.