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Written by Scott Morrison, Dow Jones
SAN FRANCISCO (Dow Jones)–Dave Young readily admits his investment philosophy is squarely at odds with mainstream practice.
Rather than buy a security and hold it in expectation it will rise in value, Young times the market. His firm, Paragon Wealth Management, jumps in and out of exchange-traded funds, trying to catch market swings at just the right moments. He trades so frequently that Paragon’s flagship Top Flight growth fund routinely turns over its entire portfolio every year.
“I just don’t trust buying and holding and hoping it works out,” says Young.
A former magician who once owned a llama farm, Young began managing his own money in 1986 as part of an effort to scale back his life. His friends saw he had a knack for it and quickly asked if he would manage their money too. In 1992, he set up Provo, Utah-based Paragon as a full-fledged money-management operation.
Paragon remains a small firm with just $90 million under management. Young says that small size is an advantage, allowing him to be nimble in a way that Wall Street titans can’t be. Young, who holds a bachelor’s degree in business management from Brigham Young University, invests his own money alongside the assets entrusted to him by institutional and individual clients.
Young’s $35 million Top Flight Portfolio focuses on the best-performing sectors within global stock markets. He moves in and out of a range of ETFs, which typically track market indices, using two groups of proprietary quantitative models as his guides.
The first group of models crunch sentiment and momentum indicators, value ratios, volume measurements and other data to identify the best-performing industries, currencies and country markets.
These models typically pick up trends that are only three or four months old. That lets Paragon lock on to the trends while they are still active. Young says he doesn’t set target prices, but reacts after a monthly review examines whether trends are breaking down.
Paragon also uses a second set of risk models that helps the firm decide how much of the portfolio should be invested in stocks at any given time.
So far, the models appear to be working well. According to Young, Top Flight has averaged a 15.75% return over its 10-year history, compared with a 4.37% average return for the S&P 500. The fund generated a 17% return in 2007 and is down 9% through the end of August this year. That compares with a 5.5% gain in the S&P 500 in 2007 and an 11% decline this year.
Top Flight Portfolio is a not a mutual fund product and so it isn’t tracked by Morningstar Inc. Investors must rely on Paragon’s self-reported results.
Until last year, Top Flight traded mutual funds and used contra funds, funds that focus on contrarian views to prevailing market sentiment, to hedge positions. But Young shifted to ETFs after mutual fund managers began to discourage frequent trading.
‘Dialing In’ On Asset Classes
ETFs also enable Paragon to “dial in” on a specific asset class. Top Flight typically holds on average of 13 ETFs at any one time and as a rule won’t invest more than 9% of total assets in any single ETF.
“We can get exposure anywhere we want it and we are completely liquid,” Young says, adding that Flight typically holds positions for between three and 18 months.
The downside of Top Flight’s active trading: a turnover rate that typically tops 100% a year, which causes higher tax liabilities for investors.
Nathan White, Paragon’s chief investment officer, says trading gains almost always offset any tax obligations. “I’ve never seen that be an issue for any of our clients,” he says.
Paragon’s technique has helped the firm identify opportunities that might have been missed by funds that use a more fundamentals-based approach to investing. Last year, Paragon’s models pointed out increasing momentum in the Brazilian stock market, which soared on the back of rising prices for minerals, agricultural commodities and oil. In April 2007, Top Flight bought shares of the iShares MSCI Brazil Index ETF (EWZ), a stake it sold this August when its models told Young Brazilian stocks were losing steam. Paragon reported a 43% gain from EWZ, which has subsequently fallen by about 23%.
Paragon similarly took advantage of momentum in South Korea last year by investing in iShares MSCI South Korea Index Fund ETF (EWY), which mirrors the performance of publicly traded securities in that Asian market. Paragon bought on a dip in mid-August last year and sold less than three months later, posting a 26% return. Paragon’s timing was prescient: EWY has subsequently plunged about 40% as rising fuel costs, weaker exports and record household debt squeezed South Korean economic growth.
But Paragon doesn’t just pick rising indices. The firm’s mean reversion models prompted the Paragon team in July to invest 4.5% of Top Flight’s assets in the SPDR KBW Regional Banking ETF (KRE), which tracks regional banking institutions listed on U.S. markets. White says the models indicated that regional bank stocks had fallen so dramatically that they were poised to rebound. The ETF has since gained more than 32%.
Despite such bets, Young acknowledges that Top Flight has not significantly outperformed the S&P so far this year, but he says that’s because the market has not fallen far enough to trigger Paragon’s risk models and take the firm’s assets out of the market.
But however the financial turmoil unfolds, Young insists that Paragon is nimble enough to move quickly once the market begins to rebound.
“There are huge bargains, such as financials,” he says.
(Scott Morrison covers technology, focusing on the Internet, for Dow Jones Newswires. He can be reached at 415-765-6118 or by email at scott.morrison@dowjones.com.)
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