11-OMG-08 Whitepaper_Gregory Mistovich 04-26-11

7/31/2019 11-OMG-08 Whitepaper_Gregory Mistovich 04-26-11

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Seeking Higher Return / Lower Volatility:

A Risk-Managed Approach That Alternates Between

Offensive andDefensive Based Methodologies.

Gregory J MistovichSenior Director - Investments

Omega Portfolio Management

Is Your Investment Methodology

Flawed?

The classic Wall Street investment advice is to hire good managers that buy good stocks,and like watching paint dry, hang in there for the long term, and forget about it. Andyes, in a classic study done in 1964 by the University of Chicago Center for Research inSecurity Prices, stock returns from 1926 to 1992 have averaged over 10% compounded

annually1. Bonds have averaged about half of that. And inflation has averaged about 3%during that period. The problem is we cannot all afford to take this decades longapproach!

Historically there have been extended periods of time of outperformance and extendedperiods of time of underperformance. For example, from 1965 to 1982 the average annualreturn was less than 1% compounded annually. This is whats called a secular bearmarket. From 1982 to 2000 the average annual return was about 14% compoundedannually, a secular bull market. Keep in mind though, that past performance is notindicative of future results.

Another problem is investor psychology. Many investors tend to buy late into a marketrally and sell when prices drop as the psychological stress to avert increasing capital lossbecomes too great to bear. In a 20 year study ending 12/31/2008 by Dalbar Associates

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Individuals who had invested in funds that tracked the S&P 500 and the Barclays BondIndex and held their funds for the entire 20-year time period would have theoreticallyearned reasonable average rates of return, 8.35% and 7.43%, respectively. In reality,however, based on actual mutual fund inflows and outflows, the average rates of returnexperienced were 1.87% and .77%, respectively.

The fact is, When the going gets tough, investors sometimes panic.

The traditional wisdom is, Its not timing the market, but your time in the market thatleads to good results. I believe the problem with that thinking is..What if one boughtthe Market in 1929? It took 25 years just to get back to even. What if one bought justbefore the 1973 oil embargo? It took about 7.5 years just to get back to even. In 1988the major index in Japan peaked out, and is still down almost 70% after 20 years. In thelast decade, there have been two declines in the S&P 500 of over 45%.

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Even if one were a more conservative bond investor, there have been several sharpdeclines in the bond markets. From 1977 to 1982, long term bonds dropped as much as50% as the yield on a 30 year US Treasury bond rose from approximately 7% up to 14%.These were some gut wrenching times in the stock and bond markets.

A Sages Advice: Breaking with Tradition.

It is impossible to produce a superior performance unless you do something

different from the majority (Sir John Templeton).

A slightly different corollary, Adhering to a value approach will tend to lead you to be acontrarian naturally, as you will be buying when others are selling and assets are cheap,and selling when others are buying and assets are expensive. 3

Humans are prone to herd because it is always warmer and safer in the middle of theherd. Indeed, our brains are wired to make us social animals. We feel the pain of socialexclusion in the same parts of the brain where we feel real physical pain. So being acontrarian is a little bit like having your arm broken on a regular basis.

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What I will introduce you to in the following pages is an approach that breaks with thetraditional hang in there no matter how much money you may lose strategy. Just like afootball game alternates between offense and defense, we shall investigate an investmentmanagement strategy and asset allocation strategy that alternates focus between scenariosseeking to maximize your income and capital, and scenarios seeking to protect yourcapital. We shall examine tools that seek to help you grow your income and capital when

risk probabilities are low, and tools that seek to help you focus on protecting your capitalwhen risk probabilities are high. We are seeking positive investment results withpotentially lower volatility. We will explore a series of processes that allow us to make,with a raised level of confidence, those difficult investing decisions that will separate usfrom the majority.

I would like to share with you some of what I have learned after 35 years of study andexperience, first as an advisor, then as an investment management consultant, and now asa portfolio manager. I have also adapted insights from a 45 year record study by JamesOShaughnessey in his book, What Works on Wall Street.

Shall we begin?

What Small Institutions and the Average Investor Would Like.

The largest institutions generally measure their performance against some type of major

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benchmark, e.g. the S&P 500, the Russell 1000. They may also measure performanceagainst a more refined index that measures certain styles or sectors. Generally they arelooking for good relative performance. For example, if the Dow went up 10%, they mightbe happy if they were up 11% or 12%. Conversely, if the Dow went down 10%, theymight be satisfied if they only declined 7% or 8%. Not so the typical individual investor.

They would like what would be called good relative performance in up markets, in otherwords, something close to the benchmark. But in down markets, they would like what iscalled absolute performance. That is, they dont want to lose money when the marketgoes down.

Impossible? Lets see. Is it possible to strive for good results with lower volatility? Whatif we approached the problem in a different fashion? Lets look at another study, onedone by the Society of Asset Allocators and Fund Timers Inc.5 For the 16 year periodstudied between July 1984 and October 2000, the average annual return of the S&P 500was 14.83%. The typical buy & hold approach, that Wall Street espouses, only showspart of the issue. That part represents the results of missing the best days in the market.

As you can see in the chart below, if you missed the best 40 days, your results dropped to5.59% annualized. So traditional wisdom therefore says one must hang in there for thelong term.

What if you were able to miss the 40 worst days? Your results would have climbed to anaverage of 27.71% annualized. But maybe we cant walk on water. So lets get real.

Unfortunately, if you look at history, most often some of the best and worst days areclustered together, both at market low points and market high points. Another impossibleminefield to navigate.

What we can ascertain is that these clusters of good and bad days occur during periods ofhigh volatility and oftentimes at significant turning points, tops or bottoms. What if wewere able to measure the risk levels in the market? A way which might help us stay out ofthe market during these high stress periods. Ah, but we would then possibly miss some ofthe best and the worst days.

So if we missed both the best and worst days our results would be better than 17% vs.14.83%, thereby avoiding a lot of psychological stress and market volatility.

Reducing volatility, a worthy goal? Yes.

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Causes of Price Movements.

What causes prices to go up and down? More buyers than sellers, and prices go up. Moresellers than buyers, and prices go down. Brilliant! The first law of economics, supply anddemand. There are a myriad of reasons why individuals and institutions may choose tobuy or sell, including everything the standard textbooks teach, e.g. value analysis, growthanalysis, economic analysis, and on and on and on. Dont forget greed and fear.

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To boil it down, it is the collective decision of all investors, both large and small, at anypoint in time, that choose to buy or sell, for whatever reason, that determines prices. It isthat collective decision to ultimately accept higher and higher prices (more demand), asthere are fewer willing sellers and less supply, that sends prices higher. And conversely,it is the collective decision to ultimately accept lower and lower prices (more supply) by

an onslaught of sellers, that will send prices lower.

Power Law Theory.

In a series of not well known, but nonetheless important studies (A theory of power-lawdistributions in financial market fluctuations. Others also cited.) by a group of scientistsat MIT and Boston University6, we find that it is the behavior of the largest institutions inthe world that is predominantly responsible for fluctuations in stock prices. The studyanalyzed millions of transactions from all over the world and encapsulated their study inpower law mathematical formulations. You can read the studies if you wish.

Bottom line as I described above: it is the collective decision of all investors, both largeand small, at any point in time, that choose to buy or sell, for whatever reason, thatdetermines prices. Add to this: the largest institutions (including mutual funds, registeredinvestment advisory firms, hedge funds, government central banks, and sovereign wealthfunds, etc.) in the world command the most assets, and by their sheer size, dramaticallyimpact prices, by their overall willingness to accept higher and higher prices as theymove large quantities of money into an asset; and conversely, their willingness to acceptlower and lower prices as they move large quantities of money out of an asset. It does notmatter what methodologies or processes they used to come to a conclusion to buy or sell.It only matters at what decisions they arrived.

Again it all boils down to Econ 101, the laws of supply and demand, but with a deeperlayer of understanding.

Look at it in a different way. If in the spring of 2007, you decided that the excesses of thecredit boom were beginning to unwind, and you had a few hundred shares of a majorbank to sell. You could sell as soon as you decided with virtually zero impact on themarket.

If you were a major institution, and you controlled a stock portfolio of$300,000,000,000.00 ( thats $300Billion), and you had a typical S&P 500 financial

sector weighting at the time of almost 25%, that means you had about $75Billioninvested in the financial area. You see the crisis starting to unfold, and you would like toreduce your exposure to the financials to about 10%. That means you have made adecision to sell 15% of your position, or over $11Billion of stock. If you were to call yourfriendly broker and give

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him/her that order to sell in one fell swoop, you would overwhelm demand and crush theprices of the stocks you intended to sell. Add to this the probability that very many of thelarge, larger, and largest institutions in the world are probably coming to the samedecision. Collectively, large institutions could have had $Hundreds of Billions offinancials to sell. You read the same books, you think the same thoughts. Ditto for the

same research. And how can one managers actions be faulted if he/she remainscomfortably in the middle of the pack? With virtually no buyers and mostly sellers, theprices would collapse.

The most logical decision would be to parcel your selling into pieces over a period ofdays, weeks, and months. You dont want to tip your hand so that others recognize yourdecision, and create a stampede for the exits. But the die is already cast and the relentlessselling march begins, ultimately driving some financial prices down over 95%.

It is these major decisions carried out over a several months-long execution process thatcan be noticed by even the casual observer. Well call these long-to-execute decisions,

trends.

It is estimated that the total amount of tradable global investment assets is around $120Trillion! As these monies are managed, and reallocated, no matter how subtle a largeinstitution may try to be, footprints are left, sort of like a bowling ball going through apython effect.

It takes these institutions weeks and months to complete stock and sector reallocations.Again, it is the culmination of these institutions collective decisions, that by their sheersize, takes a protracted period of time to execute, that creates a trend, whether up ofdown.

If you were to physically move your house off its foundation and down the street onemile, do you think you could do it without anyone noticing? Fat chance! You know thestory of the ocean-going super-tankers. It will take them a good while to get up to maxspeed. It will take them miles to slow down and come to a stop. It will also take themmiles to change direction while creating a super-giant arc.

If we were in a speed boat next to one of these super-tankers, we would have somedecided advantages in a race, even if we didnt know where they were going! Lets saywe were in a race with ten super-tankers. We would first lay back and wait for them toget underway. Once the tankers got underway and set their course, we would then be ableto project their trajectory, and then put the metal to the pedal. If they decided to changecourse, we would throttle back and simply wait for them to chart their new course. Wethen repeat our strategy again.

Mutatis mutandis, as small institutions and individuals, this is the advantage we couldgarner as we compete against larger institutions.

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Remember, it does not matter what fundamental and technical tools collectively drivethese large institutions colossal investing decisions, we simply wait for them to maketheir move, and then we kick our strategies into action.

Bottom line, institutions that spend $Hundreds of Millions on proprietary research have a

distinct knowledge advantage over the average investor or institution. [If you think youare smarter than their research teams, and have the ability to buy what they will invest innext, then this is where we part company.] But these institutions clearly have one veryserious disadvantage relative to an individual and small to mid-size institution.

It is their massive size which translates into their inability to move massive amounts ofmoney without effecting prices. When you add in the collective decisions of multipleinstitutions probably coming to similar decisions, the inability to move quickly is evenmore compounded, no matter how surreptitious they may be, or how stealthily they maytrade. They will move prices higher or lower for as long as it takes to complete their newdecision and reallocation. This is our advantage. We will use it like David versus Goliath.

When Disney decided to buy 30,000 acres near Orlando on which to build Disneyworld,do you think they put out a press release? No. They established several dummycorporations, and used several brokers, seeking to buy different parcels of land, verystealthily, and below the radar screen. But there were some astute individuals that noticedthat acres and acres of land and property were being purchased and did not readily sell anattractive price, but held out for a significantly higher price, making a small fortune in theprocess. Disney made no announcements until after they acquired every property theywanted.

We are waiting and watching for the cumulative giant footsteps of large institutions.

A Quantitative Method of Measuring the Flow of Money

Into and Out of Markets.

Is there a quantitative and probabilistic method we can use to chart the flow of moneyinto and out of various markets? Voila! Eureka ! I think so. What I am about to show youis the result of some 35 years of study and experience.

The tools which I am about to introduce to you, are just that, tools, not rules.Unfortunately the process is still 50% art and 50% science, no black boxes, but the best

compilation of tools in my estimation, nonetheless.

We will first start with some tools introduced by Charles Dow over 100 years ago thatwill begin our process of the quantitative measurement of money flows. They willultimately assist us in measuring money flows into or out of stocks, bonds, mutual funds(from the positions in their underlying portfolio), commodities, sectors, styles, asset

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classes, currencies, international markets, etc. They will also assist us in the developmentand maintenance of risk management tools.

Continued sophistication of computing power, and years of enhancements to CharlesDows tools have afforded us better insight and analysis of net money flow data. We are

still left with tools that are still only 50% science and 50% art. Nonetheless, the bestprobabilities that I have seen.

Okay. So let us begin. I will keep the concepts simple. This white paper is intended to bean introduction and not a treatise.

The first concept: the Buy Signal and the Sell Signal.

25 X Buy Signal 25 O24 X X X 24 O X X23 X O X O X 23 O X O X O22 X O X O X 22 O X O X O21 X O O 21 O O O20 X 20 O Sell Signal

The first column is the price, 20 through 25. On the left we then have a column of Xs.Xs represent a rising column. The price goes from 20 to 24 and then reverses down. Thatreversal down is represented by a column of Os. Os represent a declining column. Theprice goes down to 21. It then reverses up again to 24, another column of Xs. It thenreverses down to 21 again, the second column of Os. Finally the price reverses up againinto a column of Xs and ultimately trades higher to 25. That we will call a buy signal,represented by the ultimate decision to pay a higher price, an X that exceeds a previouscolumn of Xs. Demand (the willingness to pay higher prices) causes the price toeventually go higher. We dont care how long it takes. That is noise. We only concernourselves with the end result.

In our second example on the right, again, the first column is the price. In this examplewe start in a column of Os which represent a declining movement, with the price goingfrom 25 down to 21. The price next reverses up represented by the column of Xs, goingfrom 22 up to 24. The price then reverses down again into a column of Os going from 23to 21. The price then reverses up again represented by the second column of Xs.Ultimately the willingness to sell at lower prices takes over with the final column of Ostaking the price from 23 down to 20, the sell signal, the O that falls lower than a previous

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column of Os. Supply wins.

A column of Xs represents rising prices. A column of Os represents declining prices.The columns alternate between Xs and Os. Each column can have only Xs or Os. Weneed at least 3 Xs or 3 Os to change columns.

There are other variations of Buy & Sell signals. That is a lesson for another day. Theultimate concept is still the same. Does the willingness to buy at higher and higher priceswin out, or does the willingness to sell at lower and lower prices win out?

The second concept: The Bullish %

Every stock that we chart is either on a Buy or a Sell Signal. It does not necessarily meanthat we buy the Buys and sell the Sells. What we do is calculate the total number ofstocks on a Buy signal and on a Sell signal and then calculate their percentage. For thesake of discussion, lets say there are 2,000 stocks on the New York Stock Exchange.

1,500 are on a Buy signal and 500 are on a Sell signal. We can then calculate the Bullish% by dividing 1,500 Buys by 2,000 total stocks and come up with a result that 75% ofstocks at this time in our example are on a Buy signal. We say the Bullish % is at 75.

We calculate these numbers every day and come up with the new Bullish% every day.We can then put these figures on a graph that simply goes from 0 to 100%. We use thesame Xs and Os method. You can see this in the chart below (courtesy of DorseyWright & Associates):

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74 | | | 6 7472 | | | X O 7270 |-------|-------------------------|---X-O---------- 7068 | | | X O 6866 | | | 5 O x 6664 | | X X O X 6462 | X | X O X O X 6260 O-X-O---|-------------------------X-O-X-O-X-------- 6058 O A O | X O X 7 X 5856 O X O | 1 O X O X 5654 O X B | X X O X O X 5452 O X O | X O X O X O 5250 O-X-O---|-----5-O-----------------X-O-X------------ 5048 8 X O | X 6 X X O X 4846 O X O X | X O X O X O X 4644 O 9 O X O X O X X O X O 4 4442 O X O X O X O X O X O X X O X 4240 O-X-O-C-O-X---X-O-8-O-X-O-----X-O-X-2-X------------ 4038 O X O X O X O 4 O X 9 X O X O X O X 3836 O X O X 1 X O X O X O X O X O X O X 36

34 O X O O X 3 X O X O X O B O X O X 3432 O X O X O X 7 X O X O X O X O X 3230 O-------O-2-O-X-O-X-O---O-----X-O-X-O-X------------ 3028 | O X O X O X O X O C O X 2826 | O X O O O X O X O X 2624 | O X A X O X O X 2422 | O X O X X O X O X 2220 |-------O-X-------------O-X-O-X-O-X-3-X------------ 2018 | O X O X O X O X O X 1816 | O O X O X O X O X 1614 | | O X O X O X O 1412 | | O X O O X 1210 |-------|---------------O-X-----O-X---------------- 108 | | O X O | 86 | | O X | 64 | | O | 42 | | | 20 |-------|-------------------------|---------------- 0

--- 0 0 0 ------- 7 8 9 ----

Again you can see that we alternate between columns of Xs and Os. When the BullishPercent is in a column of Xs we are in a capital appreciation mode. When the Bullish

Percent reverses into a column of Os we change to a capital preservation mode. Just likea football game alternates between offense and defense, we do the same. Also when thechart level is above 70%, we get cautious because the majority of the buying decisionshave been made. The risk level is high. Simplistically, everybody is mostly invested andwaiting for some new magic supply money to arrive and push the markets higher. Oncethe indicators reverse into a column of Os, we go into capital preservation mode.

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38.0 | | | 38.037.0 | | | 37.036.0 | X | | 36.035.0 |-X---X-O--|-------------------------------|--------- 35.034.0 O X O X O | 34.033.0 O X O X O | | 33.032.0 8 O B C | | 32.031.0 O X O | 31.030.0 |-------O-X-O------------------------------|--------- 30.029.0 | O O X | 29.028.0 | 1 X O 5 | 28.027.0 | O X O X O | 27.026.0 | O X 2 X O | 26.025.0 |-----------O---3-X-O----------------------|--------- 25.024.0 | | O X 6 X | 24.023.0 | | O O X 9 X O | 23.022.0 | | O X O X O X O | 22.021.0 | | O X O X O X O | 21.020.0 |-----------|-------7-X-O---O-X-O----------|--------- 20.019.0 | | O X O X O | 19.0

18.0 | | O X O A 18.017.0 | | O O X | 17.016.0 | | O X O B | 16.015.0 |-----------|-------------------O-X-O-X-O---|--------- 15.014.0 | | O X O X O | 14.013.0 | | O O O C | X Top 13.012.0 | | O X O 5 12.011.0 | | O X O X Med 11.010.0 |-----------|---------------------------O-X-1-4-------Bot 10.09.0 | | O O X 9.08.0 | | 2 X 8.07.0 | | O X 7.06.0 | | 3 6.05.0 |-----------|-------------------------------|--------- 5.04.0 | | | 4.03.0 | | | 3.02.0 | | | 2.01.0 | | | 1.0---- 0 0 0 --------- 7 8 9 -----

Conversely, in a Bullish Trendline we draw a 45 degree ascending line from the bottomof a series of buy signals, after the price breaks through a previous trendline and thusreverses course. The probabilities are that issues above their Bullish Trendline tend tostay above the line. See the chart below. (both charts again courtesy of Dorsey Wright &

Associates.)

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51.5 | 51.551.0 | 51.050.5 | X 50.550.0 |---------X-O----------------- 50.049.5 | X O 49.549.0 | X O 49.048.5 | X O 48.548.0 | X O 48.047.5 | X O 47.547.0 | X O 47.046.5 | X O 46.546.0 | X X O X X 46.045.5 | X O X O X O X X 45.545.0 |-----X-O-6-O-X-O-X-O-X------- 45.044.5 | X O X O O X O X Med 44.544.0 | X O X O X O 44.043.5 | X X O O X 43.543.0 | X O X O X 43.042.5 | X O X 7 X 42.542.0 | X O X O 42.0

41.5 | X O X 41.541.0 | 5 O X 41.040.5 | X O 40.540.0 |-X-------------------------- 40.039.5 | X 39.539.0 | X 39.038.5 O X 38.538.0 O 38.037.5 37.5

The fourth concept: Relative Strength.

In the book What Works on Wall Street, James OShaughnessey tested, in a rigorousmanner, what investing strategies can actually be proven to work in the stock market. Hegot access to the Compustat database and tested everything that had been purported towork: investing based on market capitalization, P/E ratios, price-to-book ratios, price-to-cash flow ratios, dividend yields, earnings per share, profit margins, return on equity, andrelative strength - - over a long period from 1951 to 1996. He tested them independentlyand in conjunction with other variables. He found that the market clearly and consistentlyrewarded certain attributes and consistently punished others over a long period of time.

His results were rather conclusive. He wrote, Relative strength is one of the criteria inall 10 of the top-performing strategies.

In another study encompassing 1971 to 2003 Dr. John Brush did a study of commonreturn factors and their failure rates. He found that one factor led all the others: RelativeStrength7.

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We calculate Relative Strength by taking the price of one item and dividing it by anotherand plotting it on a chart. The example I have used takes a broad index of Chinese stocksand divides it by a broad world index.

113.692 | | 113.692110.113 | | 6 110.113106.647 | | X 106.647103.290 | | 4 103.290100.039 | | 3 100.03996.890 | X | X 96.89093.840 | X O 2 93.84090.886 | C O X 90.88688.025 | X 1 X 88.02585.255 | X O 85.255

82.571 | X | 82.57179.972 | X | 79.97277.455 | B | 77.45575.017 | X | 75.01772.655 O X | 72.65570.368 O X | 70.36868.153 O | 68.15366.008 | | 66.00863.930 | | 63.93061.918 | | 61.91859.969 | | 59.96958.081 | | 58.081------- 0 0 --------

------- 8 9 --------

A reversal occurred on October 30, 2008 indicating that the probabilities favored Chinaoutperforming the broader markets.

We can use these relative strength calculations on individual stocks, sectors, styles,countries, commodities, currencies, cash, bonds, etc. We can create matrices usingmassive calculations to help us discern where those supertankers of money are going. It isthe collective culmination of our giant institutions decisions to buy at higher and higherprices, or to sell at lower and lower prices, that will eventually manifest themselves inbullish or bearish trendlines, and relative strength buy or sell signals.

Adding Alpha.

Thus, there are many tools we can use to try to add incremental positive results to ourportfolio. Just one more example: Sectors. You have most likely seen the various periodic

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tables of investment results sliced and diced multiple ways. One you have probably seenis a periodic chart of performance by sector. Several years ago, Charles Ellis ofGreenwich Associates, did a 33-year study of the comparative results of perfect markettiming versus perfect stock selection. In the period from 1940 to 1973, he first assumedthat he got fully invested (using the Dow) at every bottom and got completely into cash at

every top. This resulted in his original $1,000 investment climbing to $85,000 at the endof 33 years. Then he took another approach, assuming he would stay fully invested butwould always be in the best group. Over the 33 years, only 28 switches were made, and$1,000 grew to $4.2 billion.

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Obviously nobody is going to achieve either perfect market timing or perfect sectorselection. The point is that sector selection is a very important component of improvedoverall investment performance. Each little tool that we use can incrementally help ouroverall results.

Chaos Theory.

Ill make it simple. Things happen. The best laid plans can be affected by events comingfrom left field. Unfortunately, there are many weak links in the current global financial,economic and political environment. Any one of those weak links could snap at any time,and depending on which link were to snap first, could set off its own set of deleteriousevents. There are thus myriads of potential outcomes when you factor in thecombinations of high probability events and random events. This is where a set ofproactive risk management tools comes in. (Another discussion for another day.) Itsokay to be wrong, but its not okay to stay wrong. Change when the facts change,because its easier to make up opportunity than it is to make up money. Capitalpreservation and risk management tools are very important.

Playing the piano with both hands.

Yes, fundamental research is very important. Use it to develop a fundamental worldmacro-economic, financial, and political view. Use it to assess how it translates to theU.S. economy and its markets, and concomitantly to its global counterparts.

A Gestalt Working Method.Putting it all Together.

So we try to play the piano with both hands, using the most effective tools offundamental, quantitative, and technical analysis (or is that three hands?). We remain

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flexible, using an asset allocation model that is dynamic. We can change when the factschange. We then overlay everything with our risk management tools. We are seek to usea full complement of our tools to help us answer the perennial questions of decidingwhen to buy and when to sell; what sectors to overweight and underweight; what styles tofocus on; how to allocate globally; whether to add currencies or commodities, etc. Even if

your focus is on income, these various tools can still offer an investment managementoverlay. Should we buy long term, or short term bonds? Is money going into government,corporate, municipal, foreign bonds, etc.? Should we have any money invested in foreigncurrency denominated bonds?

When a confluence of our indicators reverses down and suggest caution and heightenedrisk, we focus on capital preservation strategies. There are also strategies in our defensiveplaybook that may seek to profit during a defensive period. When money is leavingcertain areas, we seek to underweight those areas. When our indicators reverse upsuggesting risk has significantly diminished, we focus again on capital accumulation. Weseek to focus on those areas that are experiencing a net inflow of money.

If you remember the term gestalt from Psych 101, it is the collective form (connectingall the dots of information, opinion, and probabilities) that we put together from thepreponderance of the evidence at our disposal at any one point in time. Our decision willbe weighted by all the evidence we have at any one point in time from all disciplines.Even at this point, our new craft is still 50% science, and 50% art.

Our Current Hand, Still.

Under the placid surface, there are disturbing trends: huge imbalances, disequilibria,risks call them what you will. Altogether the circumstances seem to me as dangerousand intractable as any I can remember I dont know whether change will come with a

bang or a whimper, whether sooner or later. But as things stand, it is more likely that it

will be afinancial crisis rather than policy foresight that will force the change.Paul Volker, former Federal Reserve Chairman, Washington Post, April 10, 2005

An Invitation.

Without any cost or obligation, you are cordially invited to learn more about thesemethodologies and how they can assist you in the denouement of your investmentobjectives within your particular risk parameters, whether income and/or growth. Howcan I assist you in developing your investment policy statement or implementing yourinvestment policy plan?

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Although this tutorial was very basic in tenor, I welcome the opportunity to expand uponit, and discuss with you some of the competitive advantages you might garner byimplementing these additional tools and processes into your portfolio investmentmanagement, and asset allocation decisions.

We are seeking to manage our investment portfolio similarly to that of a world-classprofessional football team. We want the best players on the field at all times. Each playerhas their specific role and function. We do this with both an offensive and a defensiveteam. This is where many individuals and institutions fail. They are always on offense, orhave a very shallow defensive playbook.

They also do not have a very refined and defined methodology to discern between thetimes and situations to focus on offense and defense. When should they focus on growingtheir income and/or capital, and when should they focus on protecting their capital?

We have a definable and adaptable process of managing our world-class professional

team of offensive and defensive players. We are going to use our processes to determinewhether to run our offensive or defensive team and playbook. We are seeking aboveaverage results with below average risk.

It has been said that history repeats itself, but with a twist. We are continuously seekingto adapt to whatever hand we are dealt. Again, we say its ok to be wrong, but its not okto stay wrong. We certainly can be wrong, and, at times, will be wrong. As soon as werealize we have the wrong team on the field, or the wrong player, we will adjust.Admitting one is wrong and making the necessary correction as soon as possible is one ofthe most challenging components of investment management. We will take small losses.But letting them turn into large losses is unacceptable. Mastering this skill and process isa key trait of a world-class investor, consultant, or manager.

So even though our processes and methods are 50% art and 50% science, we still have adefinable and adaptable series of skills that I believe are better that the vast majority. Weare ready for battle in the best of times and in the worst of times.

Please allow me to teach you more, and show you how these tools and processes can beadapted to your investment objectives and risk parameters.

As Earl Nightingale would say, I wish you the best of everything.

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This white paper was prepared by Gregory Mistovich, a Financial Advisor with Oppenheimer & Co. Inc.Oppenheimer & Co. Inc. does not give legal or tax advice. Advisors will work with clients, their attorneysand tax professionals to ensure all of their needs are met and properly executed.

Indices are unmanaged, hypothetical portfolios of securities that are often used as a benchmark inevaluating the relative performance of a particular investment. An index should only be compared with amandate that has a similar investment objective. An Index is not available for direct investment, and doesnot reflect any of the costs associated with buying and selling individual securities or management fees.

Gregory J Mistovich, CRC

Senior Director - Investments

Omega Portfolio Management

617-428-5720800-828-6726

Oppenheimer & Co. Inc.One Federal Street, Floor 22

Boston, MA 02110

Transacts Business on All Principal Exchanges. Member SIPC.

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