INVESTMENT STRATEGY
History tells us that real equity returns are 5% on average since 1900, whereas bonds are about one-third of that.
In our pursuit of long-term returns that exceed the overall market, we conditioned ourselves to accept what most investors typically avoid, including embracing high levels of volatility (σ), facing steep market losses, and committing to holding investments for decades. With beginner's luck, our initial strategy revolved around investing in fundamentally sound, high-volatility strategies (‘High Vol.’), yielding supernormal profits at an annualised rate of 20% to 40%. After a decade of success, we encountered extended periods of modest returns and significant drawdowns, which disheartened even seasoned investors. In response, we added the best-in-class low-volatility strategies (‘Low Vol.’) as a 'safety net' whenever the High Vol. strategies go into hibernation.
Hence, our current allocation currently consists of:
Low-Volatility strategies (‘Low Vol.’)
Multi-strategy funds with annualised returns of 7% to 11% while accepting up to 5% annualised volatility/risk.
US Treasury bills or equivalent with ~5% yield.
High-Volatility strategies (‘High Vol.’)
Diversified, systematic global macro funds with annualised returns of 20% to 40% while accepting up to 50% annualised volatility/risk.
For astute observers, it's clear that we are taking on significantly higher magnitudes of risk in exchange for high returns. Such is the asymmetric nature of risk-taking which we have to accept if our goal is to pursue supernormal profits. There’s no free lunch.
The Managers which we allocate to incorporate these fundamental building blocks to achieve their target returns.
1. RISK PREMIA
For the past 120 years, global equities and bonds returned +5% and +2% per annum on average. Certain Managers have a ‘long bias’ to buy and continuously hold onto these Asset Classes and Factors in order to reap such persistent long term returns (also known as risk premia). Factors are a sub-group of risk premia which could be market neutral (non long bias) such as value, momentum, trend, carry and size.
If implemented effectively, risk premia strategies can be one of the most enduring sources of returns, especially for investors with investment horizons of 10 to 50 years. Most of the High Vol. funds which we invest in focus on risk premia strategies.
122 Year Annual Returns (%)
Real compounded annual real returns from 1900 - 2022 for Global Bonds & Equities: Credit Suisse Global Investment Returns Yearbook 2023
2. INSTRUMENTS
Our High Vol. funds generally invest in broad based financial instruments to capture risk-premia across a wide range of asset classes. Examples include:
Equities: Indices (S&P 500, Nikkei, DAX), industry sectors.
Bonds: Govt. treasuries, corporate bond indices.
Currencies: G10s.
Commodities: Energy, metals, agriculture.
Factors: Characteristics such as value, momentum, trend, carry and size which can be found within the major asset classes above.
In addition to broad based financial instruments, our Low Vol. managers also engage in individual company, sector or country picks to supplement a range of classic hedge fund strategies such as long/short, relative value, event-driven, arbitrage, quantitative and others.
Up to 98% of Funds underperform U.S Bond & Equity Indices on a 15-Year basis
S&P SPIVA as of Dec 31, 2022
3. DIVERSIFICATION
Asset Class Returns (10 years)
Period 2011 - 2021. CAGR Annualised Returns of Equity: MSCI All Country World Index (Gross) Cmdty: Goldman Sachs Commodity Index (Total Returns), FX: Bloomberg Cumulative FX Carry Trade Index for Managed G10 Currencies, Bond: Bloomberg Barclays Global Aggregate Index (Total Returns). Subject to rounding errors.
Diversification is known as the only free lunch in investing as coined by Nobel Prize laureate Harry Markowitz. By investing widely across different Asset Classes, Investment Strategies or Investment Teams, our Managers benefit from an overall reduction of portfolio risk or volatility whenever one item is uncorrelated with another (i.e. they do not move in the same direction at the same time).*
When overall risk or volatility is reduced through diversification, Managers may apply leverage to enhance the overall portfolio level returns. Both our Low & High Vol. managers use leverage, in different proportions, to implement their investment strategies.
* To illustrate, positive returns from equities & bonds help offset losses from currencies & commodities over the past 10 years from 2011 - 2021.
4. RISK BASED ALLOCATION
Unique to the Managers of our High Vol. strategies, risk-based allocation is an approach to portfolio management that focuses on the allocation of risk, rather than the allocation of capital. To achieve an intended risk allocation, leverage may be used which will magnify both the potential returns and losses.* Hence, the following preconditions are critical for sustained, successful outcomes:
Strict risk management limits at both instrument, asset class, and portfolio level
Ability to tolerate high levels of volatility, frequent paper losses, and having an investment time horizon of at least 5 years
Dynamic shifts in portfolio weights over time to reflect the attractiveness of each instrument and asset class.
* Broad instruments, typically in the form of futures are adjusted to the same level of risk as to the portfolio prior to allocation. For instance, if our target portfolio volatility is 30% and the U.S S&P 500 equity index futures volatility is 15%, we employ leverage that is embedded in futures to adjust the latter to 30% which will roughly double the potential return and loss of the said instrument.
“ Harry Markowitz, James Tobin & William Sharpe “”
OUTCOME
Following the above principles, our selected Managers achieved the following outcome in the past 16 years:
Outperformed the best Asset Class return in most years
Outperformed all Asset Classes over the long-term
Outperformed perhaps most managed funds over the long-term
We further share our findings through our (i) portfolio review, (ii) greatest money managers and (iii) the divestment guide.
Regards,
Stega Investment Team · May 2023
Growth of $1.00 invested since 2006
Period Oct. 2006 - Dec. 2022. Fund SQ: Quantedge Global Fund, Fund SM: Stega MultiStrats Fund (Gross) with illustrative portfolio of Millennium, Brevan Howard, Balyasny, Point72, Eisler, Verition and WorldQuant, Equity: MSCI All Country World Index (Gross), Cmdty: Goldman Sachs Commodity Index (Total Returns), FX: Inverse of Nominal Broad U.S. Dollar Index, Bond: FTSE World Broad Investment-Grade Bond Index, Subject to rounding errors.
FURTHER READS
1. Long biased
2. Broad instruments
3. Diversification
4. Risk based allocation / risk parity
Engineering targeted returns and risk, BRIDGEWATER ASSOCIATES
The Billion Dollar Interview with Quantedge Global Fund, EUREKAHEDGE
Outcome
HOW CAN WE HELP?
1. For Investors, we provide aligned, investment access with low minimums.
2. For Family Offices / Institutions, we offer capital introductions to our longest standing GP / hedge fund relationships.