#68 - Corey Hoffstein - “Risk Cannot Be Destroyed, Only Transformed"

In Episode 68, we welcome Meb’s friend and Newfound Research founder, Cory Hoffstein (or as Meb refers to him, a “fellow nerd”). Per usual, we start with Corey’s background, but then Meb jumps in by asking Corey to describe his general, 10K foot investing framework.   Corey tells us that a specific product and/or style doesn’t necessarily define him or Newfound. Rather, he believes in a consistent, well-researched process that takes into account the behavioral challenges that accompany any given investment strategy. This is because the journey is often just as important as the destination. Meb asks where Corey starts when creating a portfolio. Corey tells us it’s about the balance of risk. This is because “risk cannot be destroyed, only transformed.” Therefore, when building a portfolio, there’s no single holy grail. You need to understand the goals and fears of your client, then figure out how to balance various strategies in order to find a robust, flexible portfolio that handles risk appropriately. This dovetails into one of Newfound’s white papers, “Portfolios in Wonderland,” which tackles today’s investing climate. Corey tells us that we’re in a unique environment, whether focusing on equity valuations or interest rates. It used to be that stocks and bonds zigged when the other zagged. But in the 1980s, both became cheap. Today, we have the opposite: high equity values and low yields on fixed income. This leads to a great discussion on bonds, including Corey’s rule of thumb for estimating future bond returns, and his research into the source of bond returns – how much was due to the coupon, versus declining rates and roll yield. The guys agree that with U.S. equities richly valued, and bond yields so low, future returns of the classic 60/40 portfolio don’t look too appetizing. So, what’s the solution? Corey likes the proliferation of asset classes that used to be found almost exclusively in hedge funds. Now, we can use them to diversify our portfolios and reach a solid rate of return. The conversation bounces around a bit here – how 8%-10% returns aren’t likely going forward unless you’re invested exclusively in emerging markets... how if you let a portfolio optimizer do its thing, you’d have almost no U.S. exposure in either equities or bonds... and how, behaviorally, most people couldn’t have 0% allocated to the S&P, so finding a balance between the best portfolio and the most realistic portfolio is needed. Meb asks how much drag there is on returns when moving away from the mathematically “best” portfolio to a portfolio which investors can actually stomach. Corey tell us investors are probably giving up 50-100 basis points of return which, over the long run, is a meaningful difference. It’s not long before Meb asks about new research Corey is working on. Corey tells us he’s looking at much complexity an investor should bring into a portfolio. Some small details can make a huge difference. This leads to a great discussion about “timing luck” when it comes to trend following. More specifically, when you choose to rebalance can make a huge impact on your returns. If you’re a trend follower, make sure to catch this part. A bit later, the guys discuss another white paper from Corey, “Outperforming by Underperforming.” This leads into a conversation about the challenges of looking different with your strategy, as well as the right time-frame needed to evaluate any strategy. The conversation includes a great quiz Corey often asks his audiences regarding Buffett and how badly he has lagged the S&P at times. Chances are you’ll be surprised to hear what Corey says. There’s way more in this episode, including answers to “Should we be holding more cash?” “Is dividend investing dangerous” and “How do you factor in various global interest rates when looking at a bond allocation?” There’s also how Corey constructs multi-asset portfolios… how value works across asset classes… the biggest concerns Corey is hearing from clients today… an idea Meb has for a “weird ETF”… and of course, Corey’s most memorable trade. What is it? Find out in Episode 68.