Flirting with Models and Corey Hoffstein
My most recent “Behind the Markets” podcast guest was Corey Hoffstein, chief investment officer of Newfound Research, fellow blogger, investor and podcast host. Hoffstein’s podcast, “Flirting with Models,” was offered in a bulk download for its first season, with all episodes released together. Hoffstein has been soliciting feedback for the second season, and there seems to be high interest in a look at portfolio construction. We were lucky to preview some of Hoffstein’s beliefs on that topic ahead of a new round of guests.
Newfound’s Core Beliefs
Many investors focus on alpha-seeking strategies, whereas Newfound focuses on managing risk and cutting drawdowns with risk-focused tactical asset allocation. Instead of trying to outperform the market by, say, 100 to 150 basis points, Newfound focuses on cutting losses on a tactical basis to help investors manage their own behavior of timing the market incorrectly.
Portfolios in Wonderland and the Weird Portfolio
There are a lot of factors that affect forward-looking returns, but Hoffstein’s big-picture view involves low interest rates implying low forward-looking bond returns and higher-than-normal equity valuations implying below-average equity returns.
This creates a challenge for traditional portfolio blends, which Hoffstein wrote about in Meb Faber’s latest book, The Best Investment Writing: Volume 2.
Using a set of capital market assumptions, Hoffstein discusses optimization -produced portfolios with very large weights to emerging markets and diversifiers such as gold and alternatives, as well as long-dated Treasuries. Hoffstein’s takeaway from this “weird portfolio” optimization: to enhance returns in this environment one likely will be uncomfortable and especially uncomfortable versus the standard 60/40 mix.
Hoffstein made a great comment in the show describing the optimal portfolio as “first and foremost the one an investor can stick with.”
The great challenge of this weird portfolio is thus whether an investor can stay with it over the long run.
Conservative Portfolios: Risky with 4% Withdrawal Rate Assumptions?
Hoffstein commented that, in past environments, different standard portfolio risk profiles (such as conservative, moderate or aggressive, with varying degrees of equity/bond allocations) largely did not matter and 20/80 bond/stock mixes or 80/20 stock/bond mixes largely would have led to retirement regimes that could support a 4% withdrawal rate based on the historical experience in higher interest rate environments.
Compared with today’s environment, Hoffstein’s work suggests the most traditionally conservative (fixed income-heavy) portfolios could be the riskiest to preserve a 4% withdrawal assumption.
Trend Following to Preserve Capital in Equities
We discussed sector rotation strategies and whether one uses momentum or value metrics to pick sectors, and Hoffstein has research that suggests both can work. But trend-following overlays, Newfound’s primary focus (particularly for investors near retirement who have exposure to timing or sequence risk for their investments), are how Newfound says retirees can best manage market sequence risk—because retirees cannot earn back through jobs any losses in wealth due to market drawdowns.
While sector rotation is one primary strategy Newfound employs, Hoffstein’s team is also deploying models that employ a multifactor equity model with trend-following overlays in terms of how much cash to put in a portfolio.
Why Do Investors Need to Focus on Capital Efficiency?
Hoffstein has been a public advocate for investing in a more capital efficient manner through the “prudent use of leverage.”
One Hoffstein’s central reasons for focusing on capital efficiency is the low absolute levels of expected returns we discussed, so getting maximum exposure and return for a given set of investment dollars becomes paramount.
Our discussion about 4% withdrawal rates creating more problems for fixed income-heavy portfolios is one big motivator for the use of capital-efficient strategies that add more fixed income exposure.
Focusing on capital efficiency and the prudent use of leverage, Hoffstein and I discussed the pros and cons of this type of strategy and when it would not work—most notably when stocks and bonds decline at the same time or when rising rate environments lead to a decline in equities.
Of course, the overall portfolio mix that incorporates more capital-efficient allocations will also dictate outcomes.
What Strategies Complement a 90/60 “Portable Beta” Strategy?
Hoffstein discussed how many institutional managers focus on portable alpha strategies in which they have a portfolio of “beta” exposures but then, without using up capital in their portfolios, they will add overlays that they think can add alpha—hence the term portable alpha. This 90/60 concept brings in portable beta by adding bond future beta on top of equities and allowing the additional capital in a portfolio to be used for other “diversifying overlays” or other thematic expressions.
Hoffstein and I discussed how managed futures strategies perhaps are one of the most logical complements to a 90/60 strategy in that they package exposure to short-term Treasuries that collateralize futures positions—and that is the type of exposure missing in a 90/60 strategy that incorporates bond futures on top of equity positions.
This was an interesting conversation about Newfound’s investment approach and one of the advocates for new capital efficient ideas like the WisdomTree 90/60 U.S. Balanced Fund (NTSX).
Please listen to the conversation below.
Important Risks Related to this Article
Diversification does not eliminate the risk of experiencing investment losses.
There are risks associated with investing, including possible loss of principal. While the Fund is actively managed, the Fund’s investment process is expected to be heavily dependent on quantitative models, and the models may not perform as intended. Equity securities, such as common stocks, are subject to market, economic and business risks that may cause their prices to fluctuate. The Fund invests in derivatives to gain exposure to U.S. Treasuries. The return on a derivative instrument may not correlate with the return of its underlying reference asset. The Fund’s use of derivatives will give rise to leverage, and derivatives can be volatile and may be less liquid than other securities. As a result, the value of an investment in the Fund may change quickly and without warning and you may lose money. Interest rate risk is the risk that fixed income securities, and financial instruments related to fixed income securities, will decline in value because of an increase in interest rates and changes to other factors, such as perception of an issuer’s creditworthiness. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
WisdomTree and Foreside are not affiliated with Newfound Research and that the views of Mr. Hoffstein are not necessarily those of WisdomTree Asset Management and Foreside.
Jeremy Schwartz has served as our Global Chief Investment Officer since November 2021 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity Indexes, quantitative active strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree in May 2005 as a Senior Analyst, adding Deputy Director of Research to his responsibilities in February 2007. He served as Director of Research from October 2008 to October 2018 and as Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a head research assistant for Professor Jeremy Siegel and, in 2022, became his co-author on the sixth edition of the book Stocks for the Long Run. Jeremy is also co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” He received his B.S. in economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Jeremy is a member of the CFA Society of Philadelphia.