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RISING RATES, FALLING STOCKS: Presenting The Case For Enhanced Diversification In A Changing Macro-Economic Environment

Traditional approaches to diversification are not guaranteed to work in the future.

We are entering a unique time in history: A multi-year bull market in stocks has run out of steam, with large losses in Q4 2018 as referenced below, at the same time that a multi-decade bull market in bonds has also shown signs of turning as interest rates have begun rising from all-time lows.

This presents a fundamentally different macroeconomic environment than the past 30 years. In this new environment, traditional stock and bond mixtures may not behave the same as they did previously, and it is possible that investors need to adapt to this changing landscape with a change in their approach to diversification.

Fiduciaries likely need to think carefully about new ways to position portfolio allocations in the best interests of their clients against the backdrop of persistently rising interest rates and slower growth – or possibly an outright bear market – in stocks.

Following are real-life scenarios comparing the historical performance of stocks and bonds in relation to the Issachar Fund during various periods of financial market stress. These scenarios display the hedging potential that the Issachar Fund provided to investors in various market conditions.

Past performance is not a guarantee of future results, and individual results may vary, but such analysis can give investors insight into the historical behavior of a particular investment during certain market events.

INTEREST RATE HIKE

During the five months between July 8th, 2016 to December 15th, 2016, interest rates on the 10-year US Treasury spiked from 1.37% to 2.60%, a 90% increase in yields. This sharp move higher in interest rates had an adverse effect on the bond market.  Figure 1 displays the resulting effects that this rapid increase in bond yields had on the bond market, as measured by the Barclays US Aggregate Bond Index, as well as the performance of the Issachar Fund during that timeframe. While the so-called “safe” bond market chalked up a loss of -5.03%, the Issachar Fund remained slightly positive with a 0.26% gain, providing an effective hedge against interest rate risk. When interest rates spiked higher, it would be normal and expected that the bond market would experience losses. However, the non-interest rate sensitive nature of the Issachar Fund has helped investors offset losses in the bond market in the past, providing a more stable portfolio value.
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bear market

From October 3rd, 2018 to December 24th, 2018, the stock market suffered a precipitous loss of value. U.S. stocks, as measured by the S&P 500 Index, lost -19.25% in less than three months. After several years of strong bull market advances, this drop marked the biggest slide in stock prices investors had seen in years, reminding many investors of the potential for life-altering losses when investing in the stock market.


Figure 2 illustrates the level of risk management that the Issachar Fund was able to provide investors during that decline. While the S&P 500 lost -19.25%, the Issachar Fund was down just -0.97%.

While there are no perfect solutions and all investing involves risk of loss, this scenario highlights how the Issachar Fund provided an effective hedge against a declining stock market during a very turbulent period of financial stress.

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ENHANCED DIVERSIFICATION

Surely investors, and the fiduciary advisors who serve them, have an interest in avoiding market losses when possible. If interest rates begin to rise persistently as many economists and the US Federal Reserve Bank indicate, the traditional approach of diversifying a portfolio using only a blend of stocks and bonds may not provide the same level of volatility reduction as in the past.

Traditionally, it is assumed that when stocks go down, bonds go up and vice-versa. This negative correlation counterbalance helped to dampen volatility in a portfolio.

But what if stocks go down and bonds go down at the same time?

In an environment of a long-term trend of rising interest rates, it is possible that this scenario could present itself on a cyclical, periodic basis. In such case, investors may need to explore broadening their diversification to include active risk management vehicles, such as the Issachar Fund.

As illustrated in the charts previously, the Issachar Fund has historically demonstrated it’s potential to reduce portfolio volatility during periods of stock and bond market stress. Investors and fiduciary advisors should consider how adding the Issachar Fund could compliment current portfolio allocations, and potentially improve risk-adjusted returns in a changing macro-economic landscape.

(Performance
as of 3/31/19)		 1 Year 3 Years
Cumulative		 3 Years
Annualized		 5 Years
Cumulative		 5 Years
Annualized		 Since 2/28/14
Cumulative		 Since 2/28/14
Annualized

Issachar Fund (LIONX)
-3.66%
6.58%
2.15%
8.53%
1.65%
8.20%
1.56%

S&P 500 Index is an unmanaged composite of 500 large capitalization companies. This index is widely used by professional investors as a performance benchmark for large- cap stocks.

Barclays U.S. Aggregate Bond Index covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The index includes bonds from the Treasury, Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS sectors.  Fix income securities are subject to risks including inflationary and interest rate changes, among others.

 

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Issachar Fund
c/o Ultimus Fund Services, LLC
4221 N. 203rd Street, Suite 100
Elkhorn, NE 68022
866-787-8355
337‐983‐0676

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Important Risk Information

Investors should carefully consider the investment objectives, risks, charges and expenses of the Issachar Fund. This and other important information about the Fund are contained in the prospectus, which can be obtained by calling 1-866-787-8355 or going to the Documents page.  The prospectus should be read carefully before investing. The Issachar Fund is distributed by Northern Lights Distributors, LLC., member FINRA/SIPC

The Issachar Fund involves risks including the possible loss of principal, and may not be suitable for all investors.

The Fund may engage in frequent trading, leading to increased portfolio turnover, higher transaction costs, and the possibility of increased net capital gains, including net short-term capital gains that will be taxable to shareholders as ordinary income when distributed.  The Fund may hold cash positions and there is a risk that the sections of the market in which the Fund invests will begin to rise or fall rapidly and the Fund will not be able to sell stocks quickly enough to avoid losses, or reinvest its cash positions into areas of the advancing market quickly enough to capture the initial returns of changing market conditions.  The Fund’s investments in large capitalization stocks may underperform Funds that invest primarily in the stocks of lower quality, smaller capitalization companies during periods when the stocks of such companies are in favor.  Investments in small-capitalization and mid-capitalization companies involve greater risks and volatility than investing in larger capitalization companies.  Small and medium-size companies often have narrower markets for their goods and/or services and more limited managerial and financial resources than larger, more established companies.

The Fund invests in debt instruments which have varying levels of sensitivity to changes in interest rates, credit risk and other factors.  Many debt instruments are subject to prepayment risk, which is the risk that the issuer of the security will repay principal prior to the maturity date.  The Fund could lose money if the issuer or guarantor of a debt security goes bankrupt or is unable or unwilling to make interest payments and/or repay principal.  Changes in an issuer’s financial strength or credit rating also may affect a security’s value and have an impact on Fund performance.  The value of the Fund’s investment in fixed income securities will fall when interest rates rise and the effect of increased interest rates is more pronounced for intermediate-term or longer-term fixed income obligations owned by the Fund.  The Fund will invest a significant portion of its assets in securities that are rated below investment grade or “junk bonds.”  Junk bonds may be sensitive to economic changes, political changes, or adverse developments specific to a company.  These securities generally involve greater risk of default or price changes than other types of fixed-income securities and the Fund’s performance may vary significantly as a result.  The floating rate loans in which the Fund invests are usually rated below investment grade and are generally considered speculative because they present a greater risk of loss, including default, than higher quality debt securities and may be less liquid than higher rated debt securities.

The value of the Fund’s asset-backed securities may be affected by changes in interest rates, the availability of information concerning the interests in and structure of the pools of purchase contracts, financing leases or sales agreements that are represented by these securities, the creditworthiness of the servicing agent for the pool, the originator of the loans or receivables, or the entities that provide any supporting letters of credit, surety bonds, or other credit enhancements.  The Fund’s investment in municipal securities carries additional risk including changes in federal, state or local laws that may make a municipal issuer unable to make interest payments when due. Municipal securities backed by current or anticipated revenues from a specific project or specific assets can be negatively affected by the inability to collect revenue, for the project or from the assets. Moreover, an adverse interpretation of the tax status of municipal securities may make such securities decline in value.  In addition to the risks typically associated with fixed income securities, loan participations carry other risks, including the risk of insolvency of the lending bank or other intermediary.  Loan participations may be unsecured or not fully collateralized, may be subject to restrictions on resale and sometimes trade infrequently on the secondary market.

The Fund uses investment techniques, including investments in futures contracts, forward contracts, options and swaps, which may be considered to be an aggressive investment technique.  Investments in such derivatives may general be subject to market risks that may cause their prices to fluctuate over time and may increase the volatility of the Fund.  The use of derivatives may expose the Fund to additional risks that it would not be subject to if it invested directly in the securities underlying those derivatives, such as counterparty risk and the risk that the derivatives may become illiquid.  The use of derivatives may result in larger losses or smaller gains than investing in the underlying securities directly.   Interest rate swaps are subject to interest rate and credit risk.  Total return swaps are subject to counterparty risk, which relate to credit risk of the counterparty and liquidity risk of the swaps themselves.  There may be an imperfect correlation between the prices of options, futures, and/or forward contract and movements in the price of the securities (or indices) hedged or used for cover which may cause a given hedge not to achieve its objective.  There may not be a liquid secondary market for futures contracts and Forward currency transactions include the risks associated with fluctuations in currency.   If the Fund uses a hedging instrument at the wrong time or judges the market conditions incorrectly, the hedge might be unsuccessful, reduce the Fund’s investment return, or create a loss.  Use of leverage can magnify the effects of changes in the value of the Fund and makes them more volatile and increases the risk for loss in adverse environments.  Short positions are designed to profit from a decline in the price of particular securities, baskets of securities or indices.  The Fund will lose value if the instrument’s price rises – a result that is the opposite from traditional mutual funds.

Investments in foreign securities and securities that provide exposure to foreign securities involve greater risks than investing in domestic securities.  As a result, the Fund’s returns and NAVs may be affected to a large degree by fluctuations in currency exchange rates, political, diplomatic or economic conditions and regulatory requirements in other countries. The Fund also may invest in depositary receipts, including ADRs, which are traded on exchanges and provide an alternative to investing directly in foreign securities.  Investments in ADRs are subject to many of the risks associated with investing directly in foreign securities.  The laws and accounting, auditing, and financial reporting standards in foreign countries typically are not as strict as they are in the U.S., and there may be less public information available about foreign companies.  Investments in emerging markets instruments involve greater risks than investing in foreign instruments in general. Risks of investing in emerging market countries include political or social upheaval, nationalization of businesses, restrictions on foreign ownership and prohibitions on the repatriation of assets and risks from an economy’s dependence on revenues from particular commodities or industries among others.

No-Load mutual funds are sold without a sales charge, however other fees and expenses do apply to an investment in the Fund.

Total annual fund operating expenses are 1.86% for Class N and 1.74% for Class I. Total annual fund operating expenses after fee waiver and expense reimbursement are 1.90% for Class N and 1.65% for Class I. The Fund’s adviser has contractually agreed to waive management fees and make payments to limit Fund expenses until February 1, 2023 so that total annual operating expenses do not exceed 1.90% for Class N and 1.65% for Class.

NLD Review Code: 5119-NLD-3/16/2021

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