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New Power Fund - 101
The New Power Fund
By Sam Jones
Exclusively for InvestorIdeas.com
February 14, 2007
The General Strategy
Let’s begin with a strategy session on how we should best invest in the renewable energy sector. Again, these are my own biases and opinions and I’m sure there are a number of successful ways to do it. However, I have found the renewable energy sector to be quite volatility and erratic to say the least. And therefore risk of loss is very real if one is simply invested in any one of these stocks at the wrong time, or even late to either buy or sell. I wouldn’t count on simply investing your hard earned capital in renewables without a fair amount of oversight, monitoring and action in your account. There are precious few stocks that trend up over time in this sector at least for now. I expect that to change for the better but let’s deal with the task at hand.
To give you a few examples; I’ve watched 150% gains in 3 months disappear in as long and kicked myself for lacking the discipline to take profits. I have also sold too early when a little price volatility presented itself and missed out on some very nice gains around just around the bend. I have attempted to buy low, very low and bottom fish only to discover that the bottom is a lot lower. And of course, I have chased a few stocks higher and paid the price that so many are familiar with. These might not be uncommon stories to those of you who have cut your teeth in other speculative sectors but we still need to put together of a plan of action if we intend to make money AND keep it.
My recommended strategy for the renewable sector is pretty simple. We want to develop a system that generates high probability returns while limited the risk of substantial loss in our portfolio to an absolute minimum. Risk is something to be managed not avoided. After almost three years of trading these stocks, I think it’s safe to say that investors in this space need to be able tolerate a 10-12% periodic loss in their whole “fund” as an inherent level of risk. If you want to play in this sandbox, you had better wear goggles. I’m comfortable wearing goggles while I work. Returns will come swiftly if one understands about managing risk. To date, our own managed client accounts in our New Power fund are averaging a very stable 14%/ year net of all costs since inception (12/04) with statistically almost ½ of the risk of PBW (Powershares Clean Energy ETF). Enough with the shameless advertising, back to the strategy. We want to have a strategy in place that monitors the universe of available stocks, ETFs as well as mutual funds daily and keep our money invested in the top 10-12 leaders. I am not so proud to assume that we cannot add value to our portfolio by investing in select “Alternative energy” mutual funds when the time is right. Our strategy needs to be able to stay invested as much as possible in the strongest securities but also offer criteria for taking profits - or controlling losses. We need a system that will identify those investments that are in the early phase of new up trends. We also need to know when to sell certain positions and upgrade. Sounds like a tall order but there is an easy way to do it.
30 days is considered a “trader’s window” which provides us with a time period to operate. Every day we need to be able to quantify the universe of available renewable energy options looking back over a rolling 30 day period. I am looking for certain characteristics surrounding risk and return that tell me where to find the easy money. To me, easy money is any return that is earned without a lot of volatility or daily brain damage and we want to keep our eyes open for those types of up trends. You see, the premise behind any uptrend is this; when investors, traders, speculators, etc want to buy a stock they are in accumulation mode and there are very few sellers. Logically, in these situations, we shouldn’t expect much downside volatility. Up legs are very strong and down legs are almost non-existent. These events show up early in a new uptrend and persist until buyers become exhausted (literally tired of buying). At that point, we begin to observe stronger down days that might even equal the last up leg in magnitude and duration. Now here’s the key. If we are ranking and sorting our universe of renewable energy investments daily (looking back at the last 30 days) those that have favorable return to risk ratios will bubble to the top. When the whole sector is moving, there are more things to buy than you have money. When the whole sector is trending down, cash is king and we don’t want to get too cute with hedging. I’ve tried and there really isn’t a clean hedge for the stocks as a whole.
Our Toolbox
To affect this strategy you will need a charting program that offers you a way to monitor a family of stocks and rank them according to risk and return over a fixed 30 day period. I personally use a program called Fast track (http://www.fasttrack.net/) that does exactly that. There are plenty of charting packages out there that will handle this function but if you want to run this yourself, you’ll need one. You will also need some basis real time quotes where you can observe the universe of stocks at a glance. I personally use Telemet Orion (http://www.taquote.com/index.htm ) which is like a super cheap Bloomberg. You can also set up an account at www.quote.com as an individual investor for about $24/ month – use the Live charts Plus. And finally, you will need a brokerage account with reasonable trading costs that allow investment in stocks, ETFs and mutual funds. Most of the On-line trading platforms are fine and cheap and you probably already have one. Plan on 30-40 trades/ year. I don’t want to get into the issues of execution and who does what better because I am a position trader. I want to hold our positions as long as they meet our criteria.
The Character of the Renewable Sector
If we going to build a strategy around a single sector, we’d better know how the sector behaves. Let’s talk about that. It might surprise you to know that the renewable energy sector has a very low correlation to the traditional energy or energy services sector. Of course, a high correlation would mean that both sectors tend to move higher and lower together. In fact the correlation between the renewables and the traditionals is only .60. Scanning the field of indexes, I find not so surprisingly that the renewable energy world has the highest correlation (.79) to…… the small cap growth indices. The vast majority of the stocks in this sector are of course small caps or even micro-caps. Therefore, from a timing perspective, we should be watchful for leadership in small caps and small cap growth specifically. We are in just such a phase now and voila! most of the stocks in the renewable sector are beginning to trend strongly higher.
Speaking of timing, we should also understand that the renewable energy sector, like small and micro- cap growth tends to run at the tail end of any broad market rally in the US stock market. The reasoning is pretty obvious. Investors tend to be the most optimistic, bullish and overconfident after stocks have run substantially higher, near the top. Speculation reigns during this final phase as investors trade in liquidity for potentially larger gains by investing in the less liquid small and micro-caps. The renewable energy sector is not without large caps however. Understanding this is critical towards our risk management but it can also be used to our advantage. If we know what to expect, we can adjust our holdings toward large caps that tend to hold up better in downtrends or toward the small caps when the whole sector is in gear. We should also understand that when the broad US market does top, these are the stocks that get hit the hardest (renewables and micro-caps) so we want to Johnny on the spot about taking profits and expect to give a little skin off the top values as we move out to cash.
Next Update
I want to stop here for this update and let the general concept sink in. Next update I plan to get into constructing an actual portfolio of stocks, ETFs and mutual funds based on today’s selections, asset allocation, proper diversification and market conditions. I will also expand on more of what I have learned in trading this volatile sector in terms of which stocks are behaving well and which to avoid in general.
I hope you have found this high level overview valuable and again if you have any of your own insight you would like to share, I’d be happy to post them.
Sam Jones
President – All Season Financial Advisors
WWW.ALLSEASONFUNDS.COM
Portfolio Manager – New Power Fund
Disclaimer
Content found in the New Power Fund is subject to the terms found in the InvestorIdeas.com disclaimer at :
http://www.investorideas.com/About/Disclaimer.asp .Our featured columnists are freelance writers and may or may not hold positions in the companies discussed. Please read individual disclaimers. Nothing in the articles should be construed as an offer or solicitation or recommendation to buy or sell any specific products or securities. Past performance does not guarantee future results.
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