I recently had the honor of speaking at the Inside Smart Beta conference in NY. https://finance.knect365.com/smart-beta/speakers/john-davi The topic was “Can you time factors?”. I was also asked about Astoria’s investment philosophy, our view on the Federal Reserve, stocks, bonds, and the macro economy. Below is a summary of my main talking points.
Astoria’s Investment Philosophy
o Astoria's investment style is to blend macro and quantitative investing. We use factor ETFs to express our top down views. Our models and indicators help us determine which parts of the stock, bond, commodity, and alternatives markets look attractive. These models will determine whether we should dial up or dial down the risk of the portfolio and how much of the fund should be hedged. We then implement a set of cross-asset factor ETFs which align with our view of the macro economic cycle. Lastly, I want to emphasize that Astoria is evidenced based and data driven. We focus on probabilities and look at all the possible distributions of outcomes.
o Astoria’s Multi-Asset Risk Strategy (MARS) ETF portfolio invests across 5 asset classes. Our goal is to provide attractive risk-adjusted returns across varying economic cycles. Why does MARS invest in 5 different asset classes? Mainly because Astoria believes traditional stock and bond markets are expensive, crowded, and vulnerable given where current valuations are. For instance, Astoria invests in liquid alternatives to hedge our equity risk because the majority of the bond market no longer provides the diversification benefits it did in the past. Astoria has had an out of consensus bullish view on commodities since mid-2017. Moreover, commodities are currently providing positive carry and have in the past demonstrated positive skewness. Positive carry and positive skewness are attractive diversifiers in a portfolio.
Does Astoria Think Investors Can Time Factors?
o There is no evidence to suggest that investors can time factors in a way that is systematic, repeatable, and profitable across varying time periods. Do investors try to time factors anyhow? Yes. People will always justify some rationale for doing what they do. Investors are human and will try anything even if the odds are stacked against them. Have some investors been able to profit from factor timing? Anything is possible in the short run. However, the key is whether investors can successfully profit in a systematic, repeatable, and in a scaleable fashion?
o Astoria believes, which aligns with the evidence, that is significantly more important to pick a set of factors which are robust, pervasive, repeatable, explainable, implementable AND to harvest them for the long run. Unfortunately, the investment management industry has become enamored with short duration capital. I don’t know too many strategies (if there are any at all) that have a high probability of making money in a systematic, repeatable, and scaleable format with short duration capital.
o How many investors can time the market? Not many. If market timing is difficult, why on earth would you think you can time factors? The bottom line from Astoria’s perspective, is that investors should select factors that have compelling evidence, harvest them in a cost-effective manner, and stick with them for the long run. This strategy gives investors a higher probability of achieving attractive risk-adjusted returns than trying to time factors.
Does Astoria Invest In Single or Multi Factor ETFs?
o When compared to a single factor strategy, the evidence suggests that higher risk-adjusted returns are available if one were to invest in a diversified set of factors. At Astoria, we think the probability of forecasting when a factor will go in or out of style is low. The data clearly shows that some factors can go out of favor for decades. We believe a diversified portfolio of factors will provide a better risk-adjusted strategy than factor timing.
What Are Astoria’s Views On The Current Macro Environment?
o One of Astoria’s big calls for 2018 was to hedge risk assets and we see no reason to change that view. In fact, we have increased our hedges as the year progressed.
o Astoria believes that the market’s discussion of how the economy is late cycle has become quite tiring. Market pundits have argued the economy is in a late cycle environment for 3 years. How many people have a good track record of timing AND profiting from where we are in the economic cycle?
o Liquidity being pulled the system globally is the one risk factor that keeps Astoria up at night. Liquidity, at the end of the day, is what drives capital markets. Very few investors are prepared for a cycle with liquidity declining on the margin. In our view, the repercussions of less liquidity in the global economy can be quite significant and can have profound portfolio implications.
o Astoria doesn’t have a model for this liquidity unwind (and we doubt anyone has a good one either). Investors need to realize that there is a direct linkage between volatility and liquidity and most portfolios aren’t properly diversified based on our findings.
o Keep in mind that aside from the Fed implementing QT and hiking rates, liquidity will also decline when the ECB curtails their QE program and eventually the BOJ will follow suit. This year financial conditions have tightened significantly (see chart below), and Astoria believes this has negatively impacted US equity prices earlier this year.
Source: Bloomberg, Morgan Stanley, Astoria Portfolio Advisors LLC
o Stocks and bonds have become more positively correlated, people have been underweight alternatives, and nobody wanted to own cash during the past decade. In Astoria’s view, the overarching theme in one’s portfolio should be value, quality, and mixing in other factors (Astoria likes momentum, carry, trend) to further enhance your portfolio risk characteristics. See the chart below for Astoria’s MARS factor exposure.
Source: AlphaCore via www.myfactore.com, Astoria Portfolio Advisors. Data as of April 23, 2018.
o Astoria continues to be bullish on Emerging Market equities. Last year, MARS owned IEMG but 5 stocks drove approximately 50% of the returns and we felt as though we needed to manage our risk budget accordingly. Astoria is not trying to make a call on 5 Asian technology stocks. Emerging Market stocks have enough inherent momentum characteristics and we weren’t comfortable with the concentration risk. Hence, MARS swapped IEMG for QEMM in Q1 of 2018. During the volatility spike in January, QEMM outperformed IEMG by 200bps. This is an example of the type of diversification benefit that a multi factor ETF can provide.
o Along with EM equities, Astoria believes that Developed Market equities also provide a greater margin of safety, better EPS prospects and more leverage to global growth.
o US large cap stocks are unattractive at the index level. The S&P 500 just finished a ‘blow off the top’ earnings season and the index could not sustain a meaningful rally. That is concerning. In Astoria’s view, tighter financial conditions have been a headwind for asset prices in 2018. There are some pockets of US stocks which are attractive (Energy, Financials) but we are significantly underweight US equities relative to our benchmark.
o In Astoria’s view, there is a high probability that the peak in US equity sentiment was Q4 2017 when bitcoin reached its cycle high and the Tax Plan was announced. 2017 saw the S&P 500 produce a Sharpe Ratio over 3, a 70% ACWI / 30% Bloomberg Aggregate index saw a Sharpe ratio over 6, and there was record low index volatility. Each of these were extremes when compared to history. Hence, at the start of 2018, Astoria was advocating hedging risk assets, diversifying across factors, and utilizing liquid alternatives. Recall that liquid alternatives were an area that virtually nobody wanted to own as the S&P 500 rallied nearly 400% of the 666 lows of 2009.
o US credit continues to be an area where late cycle risks loom large. Astoria was vocal in 2017 about avoiding US IG and HY. We see no reason to change that view. Astoria does not think investors are being compensated for the risk when investing in traditional US credit. Fed tightening cycles have historically coincided with credit spreads widening and credit valuations are already rich.
o Astoria has long argued to avoid traditional US spread products. Astoria is reverse engineering the historical risk/ return characteristics of Fixed Income (i.e. income, carry, and hedging) via non-traditional credit and spread products along with liquid alternatives.
o In Astoria’s view, broad market cap weighted indices are dangerous as they provide little margin of safety, are concentrated in expensive tech stocks, and vulnerable to volatility shocks. Astoria believes diversifying across multi-factor ETFs is the better risk reward. Why? As mentioned above, the evidence suggests that higher risk-adjusted returns can be achieved when combining factors in a portfolio, harvesting them in a cost effective manner, and investing for the long run.
o For a list of which ETFs Astoria is utilizing please refer to our latest research report. https://www.astoriaadvisors.com/single-post/2018/06/04/June-2018-ETF-Insights
o Note that Astoria will be presenting at 5 upcoming conferences in the next few months. For details, refer to this blog (https://www.astoriaadvisors.com/blog/astoria-will-be-presenting-at-5-upcoming-conferences).
Best, John Davi
Founder & CIO of Astoria
For full disclosure, please refer to our website: https://www.astoriaadvisors.com/disclaimer