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1/ As I watch the basket of retail favorite equities and BTC make new highs into the end of the year, I can only hang my head.
Because my performance was absolute rubbish this year.
What went right? What went wrong? Read on.
Because my performance was absolute rubbish this year.
What went right? What went wrong? Read on.
2/ I should start by saying that my core mandates have historically sought to participate with equity market growth and preserve capital in equity market declines.
They embedded three key tilts:
1. Trend
2. Value
3. Size
(You can probably see where this is going...)
They embedded three key tilts:
1. Trend
2. Value
3. Size
(You can probably see where this is going...)
3/ Value and Size have largely been "unintended" byproducts of our portfolio design.
Specifically, we applied trend-following signals within an equally-weighted portfolio of equity sectors (e.g. Tech, Financials, Health Care, Staples etc).
Specifically, we applied trend-following signals within an equally-weighted portfolio of equity sectors (e.g. Tech, Financials, Health Care, Staples etc).
4/ Historically, this helped in periods like 2000 and 2008 when you were underweight the bubble sectors. From 2009-2020, this left you underweight everything that worked.
So why did we do it?
So why did we do it?
5/ Our aim was to manage model risk. If we allowed Tech to be 20%+, a single whipsaw in that sector could derail the portfolio.
Equal-weighting sectors served as a naive approximation of equal-risk weighting.
Equal-weighting sectors served as a naive approximation of equal-risk weighting.
6/ So cut to March 2020 this year, when signals start turning off and we start trimming equity exposure.
Except we don't cut risk all at once. No, you see, I've spent years studying rebalance timing luck, so we systematically "transition" our portfolio. https://jii.pm-research.com/content/10/1/27
Except we don't cut risk all at once. No, you see, I've spent years studying rebalance timing luck, so we systematically "transition" our portfolio. https://jii.pm-research.com/content/10/1/27
7/ That's a no good, very bad, horrible idea during what ends up being one of the fastest market sell-offs in history.
Nevertheless, trend still did decently well, putting approximately 1200bp+ between our mandates and the market by March 23rd.
Nevertheless, trend still did decently well, putting approximately 1200bp+ between our mandates and the market by March 23rd.
8/ One shining light in March was our U.S. Treasury "portable beta" overlays. With Treasury futures spiking, this positive return helped offset losses in our equity holdings.
9/ And then equities started to rebound. Within a week, our excess return had eroded to zero. Within 2 weeks, we were 1000bp+ behind.
When signals did start to turn back on, we "transitioned" back into our equity positions again, leaving us way off-sides for far too long.
When signals did start to turn back on, we "transitioned" back into our equity positions again, leaving us way off-sides for far too long.
10/ I learned a really important lesson about asset management here.
You see, if you've told everyone you run a systematic process, and you've explained that process clearly, then it's really hard to change that process even if you think the process might be broken.
You see, if you've told everyone you run a systematic process, and you've explained that process clearly, then it's really hard to change that process even if you think the process might be broken.
11/ So even though I had all the ideas that would ultimate coalesce into the Liquidity Cascades paper in my brain, I couldn't actually do anything to adjust for them within the context of my portfolio.
12/ Cut to the end of June, at which point we're back to fully invested with all trend signals positive.
But we're still invested in a way that's equally-weighted across the primary GICS sectors.
But we're still invested in a way that's equally-weighted across the primary GICS sectors.
13/ Now, I knew by this point I wanted to make some substantial mandate changes.
But it's just not that simple.
First, I had to talk to my clients about the changes I wanted to make. As you can imagine, that was like going through due diligence all over again.
But it's just not that simple.
First, I had to talk to my clients about the changes I wanted to make. As you can imagine, that was like going through due diligence all over again.
14/ Then, because I manage a mutual fund, I had to file a prospectus change with the SEC to actually give myself the flexibility to implement the changes.
The review takes 90 days minimum. Filed in late June, we weren't approved until late September.
The review takes 90 days minimum. Filed in late June, we weren't approved until late September.
15/ Finally, we had to make sure the fund had the operational ability to implement those changes! In our case, we wanted to introduce some option positions.
This required a lot of paperwork to be signed by a lot of parties. Fund administrator, advisor, custodian, broker...
This required a lot of paperwork to be signed by a lot of parties. Fund administrator, advisor, custodian, broker...
16/ It wasn't until late November that all the i's were dotted, the t's crossed, and the necessary accounts opened.
At which point, equal-weight sectors had fallen behind market-cap weighting by another 400-500bp.
At which point, equal-weight sectors had fallen behind market-cap weighting by another 400-500bp.
17/ One of the hardest lessons this year was the cost of being overly systematic.
I certainly don't advocate for throwing out a plan mid-panic, but I do believe that level heads can recognize when the facts change.
I certainly don't advocate for throwing out a plan mid-panic, but I do believe that level heads can recognize when the facts change.
18/ If you've chained yourself to slavishly follow your quantitative signals â both in your communication to clients and your prospectus â you'll find yourself swimming naked when the regime tide goes out.
And there will be almost nothing you can do about it.
And there will be almost nothing you can do about it.
19/ Our strategies did pretty much everything we wanted until March 23rd, and then just about everything we didn't for the rest of the year.
But, at this point, all we can do is look forward.
But, at this point, all we can do is look forward.
20/ Nothing will change our track record, but I believe we've made some meaningful changes that will substantially improve our process. Time will tell.
(I outlined much of this thinking in my Q3 commentary: https://blog.thinknewfound.com/2020/10/q3-2020-commentary/)
(I outlined much of this thinking in my Q3 commentary: https://blog.thinknewfound.com/2020/10/q3-2020-commentary/)
20/ If you want to learn more about these changes, feel free to contact us on our website ( http://thinknewfound.com ).
To other PMs: I hope you fared better in 2020 than I did. And I hope you can learn from my mistakes.
Wishing everyone all the best for 2021.
FIN.
To other PMs: I hope you fared better in 2020 than I did. And I hope you can learn from my mistakes.
Wishing everyone all the best for 2021.
FIN.
/CORRECTION:
Prospectus update was 60 days, not 90, and was originally filed in early June. Rule 485(a), for anyone who cares.
Prospectus update was 60 days, not 90, and was originally filed in early June. Rule 485(a), for anyone who cares.
/ P.S. In the past, Iâve argued that systematic is just the codification of discretionary. So value in discretionary must come from idiosyncratic decision.
Another way to think of this is that systematic is selling optionality. Is it being compensated? https://twitter.com/choffstein/status/880207624540749824
Another way to think of this is that systematic is selling optionality. Is it being compensated? https://twitter.com/choffstein/status/880207624540749824
