A PDF version of this commentary is available here.
- Today – August 28th, 2017 – Newfound celebrates its 9th birthday. We’re departing from our usual research commentary format to talk a bit about what we think makes Newfound special. We’ll be back to our regularly scheduled programming later this week.
- Many asset management firms embrace a product-first business strategy, aligning brand and product entirely.
- For many, Newfound is hard to pin down because we eschew this approach, preferring a philosophy-first mentality.
- We believe a philosophy-first approach allows us to avoid blind product loyalty, leaving us free to explore and research new approaches and consult openly with advisors about the solutions that may be best for their clients.
- While this approach can cause confusion about the exact services Newfound offers, we believe in the long-run it creates far more value for clients who spend the time to get to know us.
Today – August 28th, 2017 – Newfound celebrates its 9th birthday.
Much to our chagrin, even after 9 years we still often hear from advisors that they don’t quite know what we offer or what we do.
One source of that confusion is due to the fact that Newfound has changed in the scope of services it has offered over time. When we were founded in 2008, we were a small research firm licensing data from our investment algorithms. Over time, we transitioned into sub-advisory roles and eventually have come to offer our own suite of investment products.
Another source of confusion is the breadth of research we publish. Those who are initially introduced to Newfound from our research commentary are often confused about exactly what we offer because we do not seem to promote any one specific product view. Rather, our research covers a variety of topics and perspectives.
Candidly, even after 9 years, we find it difficult to define Newfound succinctly. Some might argue that this is a sign of failure: a lack of vision and specificity. We argue that it is because Newfound just simply is not a traditional asset management firm.
Avoiding the Product-First Mentality
Part of what makes Newfound hard to define is that we do not fall into the traditional “product-first” mentality of most asset management firms. Product-first firms are common in the boutique asset management space and are easily identified by the fact that they define themselves by the product they offer. “We are a small-cap value firm.” “We do dividend growth.” “We invest in distressed debt.”
The major barriers to entry in asset management – including the cost of launching and distributing investment strategies, as well as the value of track record length – makes product-first a sensible business strategy. Once you have launched, raised assets, and created a track record, you want to exploit these moats.
One of the benefits of being a product-first firm is that it creates alignment of brand and product. In fact, using common language, product-first often has the ancillary benefit of implicitly defining a firm’s philosophies. For example, it is not hard to imagine what an investment firm believes in when they say that they offer an international deep-value equity portfolio.
One of the drawbacks, however, is that it shackles brand to product. It enforces complete and blind loyalty to an approach. You become limited in your talking points. You end up in a cycle of short-term performance discussions. When your brand is your product, you are forced to take credit for good performance and dismiss bad performance as bad luck. You end up having to argue that it is always a great time to invest in your product, regardless of what other opportunities are available or what a client’s objective is.
What makes Newfound hard to pin-down is that we are a philosophy-first firm. Instead of promoting a specific product, we promote a specific set of ideas and philosophies. Product, then, is simply a byproduct.
A Philosophy-First Asset Manager
Philosophy-first allows us to talk outside the scope of the products we offer. We rarely write performance commentaries (in fact, we avoid it at all costs). We’re free to admit that much of short-term performance is random: both good and bad luck. We can spend our time working with advisors to build portfolios that actually help achieve an investor’s objectives, rather than try to shoehorn our own product in where it might not be appropriate.
What is it, exactly, that Newfound believes? As a firm, we have five broad philosophies that we believe lead to thoughtful portfolio construction. Readers of our research commentary will likely recognize these as common arcs within our writing.
It has to work in both practice and theory
We believe that investment strategies must be supported both by empirical evidence as well as a common-sense theoretical narrative. It is not enough to simply see evidence that a strategy has performed well over a variety of economic cycles, geographies and asset classes (though, that is a compelling start): we need to understand why it works so that we can determine if we believe it will continue to work in the future. We believe that the requirement that an investment approach work in both practice and theory helps us avoid approaches that have a high risk of being data-mined.
For it to work, it has to be hard
We do not believe in holy grail investment strategies. In fact, we believe that for an investment strategy to work over the long run, it must be painful to hold in the short-run. After all, if an investment approach consistently harvested excess risk-adjusted return in a manner deemed “easy,” it would attract enough investment to drive the edge to zero. Therefore, for something to continue to work in the long run, it either has to be hard to implement (structural limitation) or hard to hold (behavioral limitation). We must expect, therefore, that at some point things will go wrong.
A corollary of this philosophy is that even bad strategies have to perform well every once in a while. After all, if they consistently under-performed we could simply inverse the trades and have a strategy that always out-performs (which we just argued cannot happen).
Good strategies have to do poorly and poor strategies have to do well; call it the Frustrating Law of Active Management.
Risk cannot be destroyed, only transformed
We view every choice in investment management as a trade-off of one type of risk for another. Whenever we eliminate one type of risk, we implicitly introduce another (even if that risk is just opportunity risk). In the absence of a crystal ball, we believe the prudent choice is to diversify the risks we are exposed to. That is why we cannot, in good conscience, ever recommend a single approach or strategy as the sole basis of an investment portfolio; just as asset classes are sensitive to a variety of economic risk factors, investment strategies are sensitive to a number of process risk factors. When acting to reduce one type of risk within a portfolio, we believe it is necessary to consider the risks we are also introducing.
We don’t actually know a whole lot with certainty
There is no lack of confidence in finance. Listening to sales pitches, everybody seems to have the answer. Finance, however, is not physics. We cannot use the scientific process, run repeat trials, and isolate variables. All we have to work with is past data: so we turn to statistical models. While every piece of marketing material says, “past performance is not a guarantee of future results,” more-or-less everything we know about active management is based upon the exact opposite presumption.
But statistics can never prove a positive. Statistics does not allow for the “acceptance” of a fact, only a “failure to reject.” This is a subtle, but hugely important, difference. There is always a chance that the results we base our assumptions on are due to randomness alone. While hubris may be a wonderful sales tool, we believe humility – recognizing that everything we assume might be completely wrong – is a necessary survival tool.
The journey matters just as much as the destination
Finally, we believe that the optimal investment portfolio is, first and foremost, the one an investor can stick with. In the real world, short-term emotional decisions can threaten even the best scripted financial plan. We believe that managing anxiety is paramount to long-term investment success. Anxiety can rear its head in cases of both absolute loss and relative underperformance; finding the balance between prioritizing downside risk management and “keeping up with the Joneses” is necessary for long-term success.
From Philosophy to Product
Broadly, we try to summarize these five philosophies by simply saying we invest at the intersection of quantitative and behavioral finance. Quantitative acknowledges the importance of research-driven, evidence-based approaches; behavioral accounts for the important role that cognitive biases play in the achievability of investment results.
As a firm, these philosophies manifest in two separate suites of strategies.
In the first, we offer highly tactical, satellite portfolios that embrace the simple, systematic investment styles of value, momentum, carry, defensive and trend. These strategies are designed to explicitly prioritize downside risk management, complementing traditionally allocated investment portfolios.
Unlike product-first firms that often believe their approach is the “right” – and perhaps only – way to invest, we offer these portfolios because we believe they represent an area where a lack of thoughtful solutions leaves investors largely underserved. We do not believe tactical portfolios are inherently better: simply that they can be used to complement more traditional means of risk management, such as asset class diversification.
This is evident in our second set of offerings: our QuBe (“Quantitative Behavioral”) model portfolios. QuBe is a suite of free-to-subscribe, comprehensive asset allocation models. Within these models, we embrace a multi-manager, hybrid active/passive philosophy.
You’ll find that our own funds only comprise a small portion of the portfolios, ranging from approximately 5-20%, with the remainder of the portfolio filled with offerings from firms like Vanguard, iShares, J.P. Morgan, PIMCO, and AQR. In fact, last quarter reduced exposure to our own funds since other areas of the market seemed to offer a better relative value; a move that is likely the antithesis of product-first thinking.
We believe our philosophy-first mentality really shines in the custom mandate solutions we offer to institutions, which have historically included tactical overlays, custom variations of the QuBe models, and entirely new product concepts. (Interested in exploring what we can do for you? Reach out.)
We recognize that our choice to not take a strong, product-first stance can create confusion about who Newfound is and what we offer. For us, however, our philosophies make taking a product-first approach disingenuous. Our true north is not a product or process: it is our framework of philosophies. Philosophies that, taken together, enforce a rather humbling view. There is no holy grail investment strategy. Every strategy is going to under-perform at some point. No strategy should be the center of the investment universe. While we recognize that our unwillingness to take a product-first approach likely hurts the sale of our own portfolios, we believe our philosophy-first mentality delivers far greater value to our clients in the long run.