Manage Risk By Diversifying Your Diversifiers

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During his recent interview with Tobias, Corey Hoffstein, co-founder and Chief Investment Officer at Newfound Research discussed his approach to managing risk using a strategy that he calls – diversifying your diversifiers. Here’s an excerpt from the interview:

Tobias Carlisle: I’ve had Adam Butler on the show, who’s Gestalt at ReSolve and you’ve been on previously as well, talking a little bit about momentum. One of the things that I learned from both of you guys is to try to sort of be a little bit less strict about those look-ahead periods or to be less governed by what the back tests says specifically and sort of to take more of an ensemble approach to that. So, what is the problem really that you’re trying to solve with the Robust Equity Momentum Index?

Corey Hoffstein: Yeah, so I think if we take a step back, for us at Newfound, we’re very, very much focused on active risk management. Our view is that for investors who are trying to achieve an outcome in their financial plan, consistency in returns is really important. And so what you tend to see for most investors, the way they try to de-risk their portfolio over time is by introducing more fixed income. That’s been the plan for the last 30 years and it’s worked very well.

Corey Hoffstein: The potential problem that we see today is that as you add more fixed income into your portfolio, you’re not really introducing more diversification. You’re just really explicitly de-risking. So if you move from a more equity-dominant portfolio to a more fixed income-based portfolio, at this point where interest rates are, you’re moving into an asset class that has a very, very low forecasted real return.

Corey Hoffstein: So as you get towards retirement and you’re using fixed income to try to manage risks, the risk you’re introducing is that you might actually live longer than expected and you may therefore outgrow your portfolio with the ability…

Tobias Carlisle: I hope so, that’d be a great risk.

Corey Hoffstein: Oh, it’s a great risk until you’re out a money and then it’s a real big problem at the end of life. What we’re really pounding the table about is saying, the answer for us is diversification, that all risk management should be centered around diversification. We just really think you need to rethink diversification more holistically. It’s not just what are we investing in, but it’s how are we making those investment decisions and even when are we making those investment decisions.

Corey Hoffstein: So to go to the how, there’s absolutely nothing wrong with strategic asset allocation. It works really, really well in certain market environments. But if you’re using, let’s say, US treasuries as your primary means of managing risk in your portfolio, a rising interest rate environment can be a difficult environment for you to do well in or a prolonged low interest rate environment can mean that you miss out on a tremendous amount of portfolio growth opportunity.

Corey Hoffstein: So what we’re ultimately trying to do is say not that tactical, which is an approach that we focus on heavily, is better, not that alternatives are or not that buying puts as a means of managing risk is necessarily better, but they all just happen to work, be effective and ineffective in different market environments and that we should really think about diversifying the way in which we manage risk. Diversify our diversifiers in other words.

Corey Hoffstein: So what we wanted to bring to market, and doing this with Resolve, which I think is a really unique collaboration as far as products in the market go. But with this index, what we wanted to say was, well, how can we apply a lot of these momentum and trend-following ideas to equity market exposure to help investors potentially manage those big left-tail risks can be associated with equities, especially where equities tend to be the primary source of risk in most investor portfolios.

You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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