Newfound Research‘s Chief Investment Officer and Co-founder Corey Hoffstein sat down with Jack and Justin from Validea to talk about his own portfolio and how he manages his money.
A good interview is one where we are able to peel back the layers and learn about the nuances of investing and financial planning. Corey is a very smart guy, but in this interview, you would realize that like many of us, he makes his fair share of financial planning mistakes.
We can also learn how a quant will structure his own portfolio. I particularly like how he describes on a high level, his objective when crafting his portfolio and the end result.
He also shared his philosophy towards portfolio construction with leverage, the benefits of being open to learning, and why sub-optimal strategies may sometimes be more sustainable.
You can watch the podcast here:
What He is Trying To Achieve For His Investments
His goal shifted over time:
When young: Get to the point where Corey is comfortable with the assets he has.
What is enough:
Assets Greater than Future Liabilities
Corey is a very big believer in liability-driven investing (LDI) (Basically, all your future needs/goals are a liability that you can calculate a present value. Your assets today need to fund these liabilities)
At this point, Corey felt that his income and investment assets superseded his future liabilities.
Now: What is money for?
Corey concluded that he:
- He doesn’t want to think about money.
- Instead of saying money cannot solve all problems, re-frame and consider that money can de-stress a lot of problems. (e.g. free up time)
- He is going to have children soon, so education for kids is a big goal. His parent allow him to graduate without debt, so he would like to do something similar if possible.
Corey’s Retirement: Changing the Pace of Life
Corey is 35 this year and has been running NewFound Research for 15 years. Entrepreneurship has been the fast pace and hectic.
His goal is to be able to take his foot off the pedal when he reaches 50 years old.
He believes in the philosophy:
If you don’t use it, you lose it.
You need physical and mental sharpness, so Corey intentionally builds this into his life exploration.
He hopes in fifteen years’ time, he can slow down and be present in his kid’s life.
Corey shared his dad’s early retirement experience (8 min 20 sec).
He hopes to slow it down like his dad and not be as hands-on during the later years.
The Three-Legged Stool Portfolio
The following diagram illustrates Corey’s current asset allocation:
Corey explains that based on modern portfolio theory, and efficient frontier, we should find the portfolio with the best excess return per unit risk and then leverage it up.
But most people are afraid to do that in their investments but are very willing to do it for real estate.
“You can create a much more well-diversified, sustainable portfolio if you are willing to mix asset classes and then add on leverage to a risk level you want.”
Corey revealed that as a finance person, he is constantly being scrutinized, and it is challenging for him to manoeuvre trading individual securities with leverage. So he has spent a lot of time packaging his ideas into funds so that he can invest in them.
“Warren Buffett was buying high-quality, profitable companies, then leveraging them 1.6 times.”
He crafted a Three-legged Stool Portfolio Strategy:
- The first is using asset classes or strategies to generate long-term compounded returns around risk premia.
- Then, we consider #1 together with the economic and inflation risks so that we are not too exposed in specific economic regimes.
- Risk cannot be destroyed can only be transferred. Corey likens risk to a big bowl of playdough. If our portfolio is very concentrated, our portfolio is very concentrated in the regime of economic growth. If the economy suffers, your portfolio is in for a significant drawdown. He is trying to take away risks in that economic growth regime and introduce risks in other regimes. This is as if we are smashing the playdough and spreading it out.
His portfolio is:
- Based on three asset classes (Public and private equity, bond futures, managed futures)
- Find the key long-term return drivers. To get returns, you have to take risks.
- Stocks & bonds represent the two significant “muscle movements.” regarding risk premia available. Corey thinks it is “highly defensible” why you should earn good returns by holdings stocks and bonds.
- The big risk of holding a stocks and bonds-only portfolio is that both asset classes are highly susceptible to inflation shocks.
- We should have a third leg of a stool that does well in an inflationary environment. Corey does not favour commodities because commodities are inferior during deflation.
- Managed futures, which can go long or short global futures markets, historically exhibit low correlations with stocks and bonds and have absolute return-like characteristics. Managed futures has also done well during equity crisis and inflationary periods.
“Your human capital is like you are long a bond.”
Corey liken that the salary from our bond can be consider an inflation-protected, credit bond.
If you want, you can model your human capital, by calculating the net present value of a stream of your future income.
For a young person, they have a huge human capital, which means a huge bond position.
They can afford to have more equity allocation.
There are white papers that argue you should have a more leverage equity portfolio.
Conversely, as you get older, you might not want to just have stocks in your portfolio.
Corey has so much bonds (for a 35-year-old) because as an entrepreneur, he struggles to “model” his human capital.
“I want to build my investment portfolio as “all-weather” as possible. Owning bonds allows me to capture the risk premium.”
What people misunderstand about bonds is that your portfolio is less risky because of the low correlation but that bonds are just lower volatile then a lot of other things. We can achieve the same effect if we use cash instead.
“When you work a few years longer, you are adding more bonds to your portfolio, offsetting more of your future liabilities.”
Corey uses a fund which invest in bond futures to give him exposure to treasury bonds across a few different durations.
“I messed up my equities allocation.”
Corey explained that he has the good fortune of able to harvest a decent amount of taxable money early in his career and he decide to invest in individual companies that are predominately tilted towards high-quality, profitable, dividend-paying.
The equities did so well that he lost his ability to tax lost harvest.
In the US, asset location is critical. When you sell, you need to pay long or short-term capital gains tax. If you have losses, you can harvest those losses to offset your tax bill.
The cost basis on Corey’s individual stocks is low, which means that the capital gains that will be tax is substantial.
“If I were to pinpoint my main mistake, it was not thinking ‘how would this be ten-years down the road?'”
He lamented that if he has invested in a high-quality-based ETF, what he ‘owns’ technically can be reconstituted and rebalanced better.
“Being knowledgable in one area of investment does not mean I am knowledgeable in all areas of investments.”
At 23 min 15 secs, Corey explains his embarrassment of not taking advantage of certain tax-advantaged accounts.
He stresses that a good adviser can add alpha just by their sophistication.
At this point of his life, he finds that his time might not be well spent finding way to avert taxes as opposed to growing his wealth better.
Core Idea of Return Stacking
Corey wrote a paper about returns stacking, explaining what it means.
[White paper] Return Stacking: Strategies for Overcoming a Low Return Environment
To form a more well-rounded, less correlated portfolio, we can add hedging strategies to the portfolio.
However, the portfolio will have lower volatility and less risk. This means the return will be lower than equities.
So the traditional strategy has a funding problem.
Return stacking introduces leverage to the portfolio. With leverage, the risk level goes up, and we hope to be able to capture the returns that come with the risk.
Newfound Research recently launched a fund that, for every $100 invested, it gives you $100 bond exposure and $100 managed futures exposure. For a 60% equity and 40% bond allocation investor, it allows you to replace 20% of the bond with this fund. This takes your allocation to 120% with more diversification.
The Right Amount of Leverage to Apply to Your Investment Portfolio May Need a Behavioural Layer
Corey says that getting the right amount is more art than science.
You can take different portfolios and backtest different amounts of leverage applied.
If you compute the different allocations, with different leverage level, you will find that the shape of the chart resembles a hump. The peak of the hump represents the ideal amount of leverage with the highest return. Before that hump, you are not taking enough leverage; after the hump, you are taking too much leverage.
The problem is that if the time period you backtested is different, and the length of investment is different, the ideal leverage level is DIFFERENT, If the period has a 2008 GFC, the leverage level would be way lower.
“The art of what I try to do is I look at all of these subperiods, what level of leverage do I think is more safe and sustainable over these shorter time horizons that, in theory, still gets me to that long-term optimal leverage level. When I plotted these charts over the long run (30 years), I ended up pretty far to the left of ‘the ideal number’. For example, the ideal number might say I should be 3 times leverage but the better number is 1.5 times. that 1.5 times is more sustainable because there might be a 90% drawdown that is hidden at one point in that 3 times leverage.”
“I am trying to maximise my returns, but respecting some drawdown constrains that make it more sustainable.”
Kyith: To earn those great returns, you will need to withstand those high-leverage drawdowns first.
We should frequently rebalance our portfolio a little at a time.
The problem with many finance people is compliance oversight constraining us. If we are in individual stocks, we need to submit trade requests before we can do all these stuff.
Corey wants to slowly sell and move into the funds he crafted so that rebalancing can take place within the fund.
He will look at his portfolio on an asset class level once a month to see if they are out of whack, and make small changes using tax loss harvesting their position.
“I have some doubts about how my Private Equity investment will work out.”
His private equity investments do not include his company Newfound Research.
- In early 2010, he invested in a fund that invests in seed-stage tech companies around the world.
- In 2014/15, he invested in a private equity fund. Corey explain that in the PE space, only a few firms do it well and he was fortunate to be able to invest in one of them.
- He invests in safe notes, which is a typical structure to seed funding to start-ups of his friends’ companies when they need capital. These are people he works with, and he feels safe working with them to invest his own money.
“I am not sure whether I earn an adequate premium in the private space. I think if I taken the money I had invested in the seed stage and put it into the Nasdaq, I might have the same return but 100% more liquid.”
“I am up ostensibly five times in the seed fund I invested in but there is no liquidity currently so I am not sure if I would be able to get my money out. They invested in this company call Canva in the seed stage and Canva has gotten massive. About 80% of the fund’s value is in Canva, so now I have a massive allocation to this company called Canva.”
Reflections on his Crypto Experience and Portfolio Sizing
Corey was trained in computer science and read the white papers early on but only got involved in 2021 when most of the crypto infrastructure was already set up.
He was fortunate that he was living in Cayman, which allowed him to trade on international exchanges.
As a quant, there were many easy strategies such as cash & carry, which is long underlying crypto and short the futures. There is a vast 20% annualized premium.
He was defi-yielding farming (in his word the platforms were providing incentives to grow the network), flipping NFTs.
From a tax perspective, investing in crypto is a nightmare for Corey.
Corey doesn’t feel that it is healthy NOT to participate in new technologies because you can grow dismissive about things.
“For young traders, trading NFTs is good practice for trading illiquid assets, provided they don’t get sucked in. You learn about stuck inventory, how to work a market, how to do things OTC. When FTX was around, they can learn to write trading bots because there were API to do that. Just be careful because we can easily get sucked in.”
The Value of Financial Planning
Corey shared something that was weighing on his mind about his estate planning:
- As an individual, if he gets hit by a bus, his assets will go to his dad, who will do whatever he wants with the money.
- After he got married, if he gets hit by a bus, and his wife is still around, the assets will go to his wife, and his dad, who is versed in finance will be able to help figure it out as the instructions are there.
- Now that he is going to have a kid, if he gets hit by a bus, and his wife is still around, how can he structure his assets in such a way that it makes his wife’s life easier?
- If both of them gets hit by a bus, how does he structure his estate for the kid?
He definitely needs some estate planning help but am not sure if a financial adviser will work for him because he is so well-versed investment-wise.
The host and Corey got into a discussion that their loved ones may need to restructure their portfolios:
“I had an honest conversation with my wife the other day. The way I managed our money is the way I think is optimal for us. But this will not make much sense to her (she does not know what is managed futures.). Even if the managed futures are in a fund, that structure will not help her much.
If I took my assets and put them in high-quality dividend-paying companies instead, which is a sub-optimal strategy, she just knows that every month, there will be money that is coming out and never have to touch the portfolio.
There is something to be said about a sustainable investment strategy that matches your lifestyle.
If I kick the bucket early, there is some justification for her to restructure the portfolio rather than having to go in and sell the portfolio a little by little.”
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