This commentary is available as a PDF here.


  • There is no holy grail investment style that will out-perform in all market environments.
  • Being systematic and disciplined in our use of active strategies is the best way to capture out-performance because we don’t know when the out-performance will happen.
  • Diversifying across several active approaches – all of which have independently proven to add value in different market environments – can help smooth out short-term underperformance of a single approach.

While October saved many investors from what would have otherwise been a dismal year in the S&P 500, the same cannot be said for anyone whose investments weren’t constrained to core U.S. equity and fixed income.  Both foreign developed and emerging market equities finished the year down.  Of the sixteen high-income asset classes we track, eleven declined in 2015.  Commodities were absolutely decimated with gold (GLD), agricultural (DBA), base metals (DBB), and energy (DBE) down 10.7%, 17.2%, 25.3%, and 35.9%, respectively.

And these weren’t just one or two percent losses.  Of the 27 asset classes and sub-asset classes we analyzed, 11 lost more than 5% and 8 lost more than 10%.

While broad U.S. equities were one of the few refuges in 2015, they were by no means immune to malaise of 2015.  Small-caps declined 2.1% and value ended the year 8.4% lower.  Even the great Warren Buffett and his Berkshire A shares underperformed SPY by nearly 14%.

Unsurprisingly, when global assets have such a bad year, many asset allocation approaches will follow suit.

To illustrate this, we constructed simple ETF/mutual fund models[1] for five of the more well-known allocation strategies.  We looked at 60/40, risk parity, the Ivy Portfolio, the Permanent Portfolio, and tactical asset allocation.  Of the five, only 60/40 finished the year positive.

For many advisors and their clients, this was a frustrating year, plain and simple.  However, with this frustration, comes the opportunity to remember some key investing observations that can be forgotten in the strong bull market of 2009-14.

Observation #1: There is no holy grail.  

Asset classes and strategies will always ebb and flow through periods of out and underperformance.  There is no holy grail in investing.  No strategy will beat the market year in and year out.  It just won’t happen.

The five asset allocation approaches listed above all outperformed the U.S. equity market on a risk-adjusted basis over the 19-year period we examined (1997 to 2015).

However, they also all suffered through shorter-term periods of underperformance.

On average, there was a 56% probability that a given strategy would underperform U.S. equities in a given year.  And this underperformance was by no means limited to a percent or two.  In fact, in the years where the strategies underperformed, the average magnitude of underperformance was almost 10%.

In this light, 2015 looks downright normal.

Per-Year Strategy BreakdownSee Important Disclosures at the end of this document for more information regarding these investment strategies.

Observation #2: Successful investing is one part intelligence and one part discipline. 

Recently, Clifford Asness, Antti Ilmanen, and Thomas Maloney of AQR wrote a piece forInstitutional Investor titled Market Timing Is Back in the Hunt for Investors.

In the introduction they attribute a quote to the late Paul Samuelson, who during the technology bubble of 1999-2000 said something along the lines of, “Market timing is an investing sin, and for once I recommend you sin a little.”

The rest of their article provides ample evidence for the use of value- and momentum-based market timing methodologies within a broader asset allocation framework.

We would add to this statement that if investors are going to sin, they should do so systematically.

One of our favorite examples of sinning with consistency is Warren Buffett.  In an interview with Bloomberg TV, Cliff Asness had this to say regarding Warren Buffett and his phenomenal success:

“I used to think being great at investing long-term was about genius.  Genius is still good, but more and more I think it’s about doing something reasonable, that makes sense, and then sticking to it with incredible fortitude through tough times. 

Of course [AQR] found [Warren Buffet] was fantastic – but not quite as fantastic.  His track record was phenomenal…but human phenomenal.  

What was beyond human was him sticking with it for 35 years and rarely, if ever, really retreating from it. 

That was a nice little lesson that you have to be good, even very good, but sticking with it and not getting distracted is much more the job.”

In 2015, Warren Buffett’s Berkshire Hathaway A shares underperformed the S&P 500 by nearly 14%.  Remember 2009 when the market rallied after its significant 2008 losses?  Those same A shares underperformed the market by more than 20%.

Has Warren lost his magic touch?  Probably not.  He was up 27% in 2014 when the market was only up 13%.

His style, however, can sometimes be uncomfortably idiosyncratic.  But that’s nothing new.  Any time you go off benchmark, that’s going to be the result.  To significantly out-perform, you have to be willing to be significantly different.

We can take a look at how different investment styles have performed throughout the years to see that they can go through short-term periods of significant under-performance.

Annual Factor PerformanceSee Important Disclosures at the end of this document for more information regarding the above investment styles.

Value is a striking example in 2015.  Most investors believe that buying cheap stocks will help them out-perform the broad market over long horizons: but “cheap” significantly under-performed the market this year.  We doubt this will cause broad investor sentiment to change from the belief that value will still out-perform in the long run, but it may cause some investors to take some value exposure off the table.

And this is a problem, because investing is a team sport.  A manager needs to have the conviction to stick with his approach, but it is equally important that the client has the discipline to stick with the manager.

Continuing with the Buffett theme, consider that an investor that sold Berkshire every time it underperformed the U.S. equity market for a year would have only captured about a quarter of Buffett’s gains.

The same is true for almost any of the broad factor approaches above.  While each of the five factors outperformed domestic equities over the full period, an investor who constantly rotated to the approach with the best 3- or 5- year track record would have eroded most, if not all, the benefit.

Long-term Factor PerformanceSee Important Disclosures at the end of this document for more information regarding these investment strategies/styles.  The above chart reflects Sharpe Ratio for these different investment strategies/styles from 1997 through 2015.

Instead of trying to figure out which style was the best, simply equally diversifying across all of them helped achieve their long-term out-performance while limiting exposure to short-term relative volatility.

This same concept holds for asset allocation styles as well, which brings us to observation #3.

Observation #3: Don’t put all your eggs in one strategy basket. 

While picking a thoughtful asset allocation approach and sticking to it is a huge step in the right direction, picking a set of complementary asset allocation strategies is even better.

An extreme example would be to allocate 20% of a portfolio to each of our five example allocation models.  This approach would have hypothetically generated a Sharpe ratio of 0.52.  A Sharpe of 0.52 is better than four of the five individual models, only 0.01 less than the best performing of the five, and more than 2.5x higher than the broad U.S. equity market over the 1997 to 2015 period.

The benefits of strategy diversification are so strong that it is nearly equivalent to being able to choose the best performing strategy with perfect foresight.  Strategy diversification is so powerful because each strategy, if driven by sufficiently different investment processes, will cycle through periods of out and underperformance independently.  Their ebbs and flows should at least partially cancel out, creating a more consistent return profile.

Practically speaking, having five separate asset allocation approaches in one portfolio may not be operationally feasible.  However, using two or three is very possible for the average investor, especially given the continued explosion of the ETF market.  One example would be pairing a strategic allocation tailored to a client’s risk tolerance with a tactical model.

Strategy Sharpe RatiosSee Important Disclosures at the end of this document for additional information regarding the above investment styles.  The above chart reflects Sharpe Ratio for these different investment styles from 1997 through 2015.


2015 was a tough market for almost any allocation approach that wasn’t solely invested in U.S. equities.  That said, long-term evidence still suggests that there are many active approaches that can be used by investors to achieve superior risk-adjusted returns.

The key, of course, is having the discipline to stick with those approaches when they under-perform in the short-run.  At the very least, investors must not be tempted to chase what has been working well recently, as this consistently erodes any performance benefit from the active strategy.

Finally, diversification once again proves to be one of the simplest techniques investors can apply to tilt odds in their favor.  Whether across equity styles or asset allocation methods, diversification can help investors achieve the long-term relative out-performance offered without necessarily suffering the full brunt of short-term underperformance.

[1] These models/investment strategies are not available for investment through Newfound.  These hypothetical models were constructed in January 2016 for purposes of evaluating historical market performance (and therefore are backtested).  Please see the Important Disclosures at the end of this document for more details regarding the objectives and components of each of the five portfolios, as well as other important information.

Important Disclosures

The Ivy portfolio consists of a 40% allocation to global equities (VHGEX) a 20% allocation to fixed income (VBIIX), a 20% allocation to commodities (DGL and DBC and related indices prior to ETF launch), and a 20% allocation to REITs (VGSIX). The permanent portfolio consists of a 25% allocation to U.S. Equities (VTSMX), a 25% allocation to long-term Treasuries (VUSTX), a 25% allocation to cash equivalents (VFISX), and a 25% allocation to gold (DGL). The risk- parity portfolioconsists of an equal risk contribution allocation to global equities (VGHEX), fixed income (VUSTX and VBIIX), and commodities (DGL and DBC). The 60/40 portfolio consists of a 60% allocation to global equities (VHGEX) and a 40% allocation to fixed income (VBMFX). The tactical equity portfolio allocates to U.S. equities (VTSMX) when its 50-day moving average is above its 200-day moving average and to cash equivalents (VFISX) otherwise. U.S. equities are represented by VTSMX.  The best five year portfolio is rebalanced annually to invest in the portfolio with the highest total return over the prior five years.  The best three year portfolio rebalances annually to invest in the portfolio with the highest total return over the prior three years.  The equal weight portfolio of five strategies consists of an equal-weight allocation to the Ivy portfolio, the risk-parity portfolio, the 60/40 portfolio, the permanent portfolio and the tactical portfolio.  Data sources for these portfolios include Yahoo! Finance and Newfound Research LLC.  Data is through December 24, 2015.

Value is represented by the Guggenheim S&P 500 Pure Value ETF (ticker: RPV) and the underlying index prior to the ETF’s launch. Minimum volatility is represented by the iShares MSCI USA Minimum Volatility ETF (ticker: USMV) and the underlying index prior to ETF launch. Momentum is represented by the iShares MSCI USA Momentum Factor ETF (ticker: MTUM) and the underlying index prior to ETF launch. Dividend Growth is represented by the ProShares S&P 500 Dividend Aristocrats ETF (ticker: NOBL) and the underlying index prior to ETF launch. Size is represented by Vanguard Small-Cap Index Fund (ticker: NAESX). The S&P 500 is represented by the SPDR S&P 500 ETF (ticker: SPY). 
 Data sources include Yahoo! Finance and Newfound Research. 
 Data is through December 24, 2015.

This document (including the hypothetical/backtested performance results) is provided for informational purposes only and is subject to revision. This document is not an offer to sell or a solicitation of an offer to purchase an interest or shares (“Interests”) in any pooled vehicle. Newfound does not assume any obligation or duty to update or otherwise revise information set forth herein. This document is not to be reproduced or transmitted, in whole or in part, to other third parties, without the prior consent of Newfound.

Certain information contained in this presentation constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of an investment managed using any of the investment strategies or styles described in this document may differ materially from those reflected in such forward-looking statements or in the hypothetical/backtested results included in this presentation. The information in this presentation is made available on an “as is,” without representation or warranty basis.

There can be no assurance that any investment strategy or style will achieve any level of performance, and investment results may vary substantially from year to year or even from month to month. An investor could lose all or substantially all of his or her investment. Both the use of a single adviser and the focus on a single investment strategy could result in the lack of diversification and consequently, higher risk. The information herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. You should consult your investment adviser, tax, legal, accounting or other advisors about the matters discussed herein. These materials represent an assessment of the market environment at specific points in time and are intended neither to be a guarantee of future events nor as a primary basis for investment decisions. The hypothetical/backtested performance results and model performance results should not be construed as advice meeting the particular needs of any investor. Past performance (whether actual, hypothetical/backtested or model performance) is not indicative of future performance and investments in equity securities do present risk of loss. The ability to replicate the hypothetical or model performance results in actual trading could be affected by market or economic conditions, among other things.

Investors should understand that while performance results may show a general rising trend at times, there is no assurance that any such trends will continue. If such trends are broken, then investors may experience real losses. No representation is being made that any account will achieve performance results similar to those shown in this presentation. In fact, there may be substantial differences between backtested performance results and the actual results subsequently achieved by any particular investment program. There are other factors related to the markets in general or to the implementation of any specific investment program which have not been fully accounted for in the preparation of the hypothetical/backtested performance results, all of which may adversely affect actual portfolio management results. The information included in this presentation reflects the different assumptions, views and analytical methods of Newfound as of the date of this presentation.

Performance during the backtested period is not based on live results produced by an investor’s actual investing and trading, but was achieved by the retroactive application of a model designed with the benefit of hindsight, and is not based on live results produced by an investor’s investment and trading, and fees, expenses, transaction costs, commissions, penalties or taxes have not been netted from the gross performance results except as is otherwise described in this presentation. The performance results include reinvestment of dividends, capital gains and other earnings. As the information was backtested, it does not reflect contemporaneous advice or record keeping by an investment adviser. Actual, live client results may have materially differed from the presented performance results.
The Hypothetical Information and model performance assume full investment, whereas actual accounts and funds managed by an adviser would most likely have a positive cash position. Had the Hypothetical Information or model performance included the cash position, the information would have been different and generally may have been lower. While Newfound believes the outside data sources cited to be credible, it has not independently verified the accuracy of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.

This document contains the opinions of the managers and such opinions are subject to change without notice. This document has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. This document does not reflect the actual performance results of any Newfound investment strategy or index.  This purpose of this document is to explain Newfound’s beliefs that:  there is no holy grail investment style that will out-perform in all market environments; being systematic and disciplined in use of active strategies is the best way to capture out-performance because we don’t know when the out-performance will happen; and diversifying across several active approaches – all of which have independently proven to add value in different market environments – can help smooth out short-term underperformance of a single approach.

The investment strategies and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation.

No part of this document may be reproduced in any form, or referred to in any other publication, without express written permission from Newfound Research.

© Newfound Research LLC, 2016.  All rights reserved.

Corey is co-founder and Chief Investment Officer of Newfound Research, a quantitative asset manager offering a suite of separately managed accounts and mutual funds. At Newfound, Corey is responsible for portfolio management, investment research, strategy development, and communication of the firm's views to clients. Prior to offering asset management services, Newfound licensed research from the quantitative investment models developed by Corey. At peak, this research helped steer the tactical allocation decisions for upwards of $10bn. Corey holds a Master of Science in Computational Finance from Carnegie Mellon University and a Bachelor of Science in Computer Science, cum laude, from Cornell University. You can connect with Corey on LinkedIn or Twitter.