1. Eliminating Emotion
A systematic process drives the core of our business. That means we use a rigorous, rules-based framework grounded in data science to generate investment decisions. Our process begins with the collection and interpretation of a large amount of data. We not only utilize market price information, but also other data series that allow us to infer important information about market dynamics and underlying economic conditions. Our systems analyze this data in many frameworks over numerous time horizons, resulting in the unique view of markets and the economy reflected in our portfolios.
2. Focus on the Observable
Through our research and testing process, our systems hone in on actionable signals derived from interpreting the data. The result is a range of expected return and risk characteristics for each test we produce. We only implement a new model if it meets our strict requirements. Our checklist includes not only return potential, risk contribution, and statistical significance, but also the “smell-test” of whether a signal is merely noise or is in fact capturing an understandable market characteristic. We choose to only implement strategies that meet all these criteria, avoiding randomness to help build strong portfolios that can generate long-term returns.
3. Diversification 2.0 - Using Uncorrelated Strategies to Drive Risk Management
Since Harry Markowitz introduced modern portfolio theory in the 1950s, the financial industry has touted the importance of diversifying asset classes. Though the market has certainly experienced several cycles in the decades following Markowitz’s breakthrough, the period has proven mostly great for stock and bond investors. Since 1980, U.S. stocks have produced double-digit annual returns on average and bond yields have steadily fallen, benefitting bondholders. In such an environment, diversification is easy; buy a mix of stocks and bonds, rebalance, and enjoy the ride. These days, we believe traditional diversification techniques are riskier than in years past, with equity market valuation near historical highs and bond yields and credit spreads near historical lows. At the same time, central bank activity and geopolitical dynamics continue to significantly impact asset class returns and volatility, and low implied volatility for most major asset classes suggesting investors are complacent and vulnerable to seismic market dislocations.
At Martello, we pursue strategy diversification, which calls for diversifying a portfolio by allocating to multiple uncorrelated active strategies. This is a different take on Modern Portfolio Theory, and one that we believe is a more robust risk management tool than simply mixing a portfolio of stocks and bonds. The benefits of diversifying amongst strategies are intuitive; by using multiple strategies that analyze markets in different ways, the total impact from any specific approach going through a tough period is dampened. We implement strategy diversification in our practice by creating different, independent models across a variety of investment disciplines (macroeconomic, systemic risk, market trends, volatility, value, yield, etc.) and implementing them in a multi-strategy to reduce risk and smooth the ride for our investors. One single model is never as powerful as a group of them.
Traditionally, a well-diversified portfolio of strategies was only achievable by large institutional investors that could allocate to a group of hedge funds and other alternative investments. The fund-of-fund business also relies on strategy diversification. However, these products typically come with high minimums, exorbitant fees, and opaque structures. Our approach capitalizes on the benefits of a multi-strategy, contained in a single, transparent investment portfolio, without multiple layers of fees or other hidden costs.
4. Harnessing the ETF Revolution
•Low cost: ETF operating expenses are generally lower than mutual funds, reducing the total fee paid by clients. Many custodians also provide a commission-free ETF lineup, further reducing total costs.
•Liquidity: Global assets in ETFs have reached over $5 trillion, and most funds are very easy to trade.
•Broad offering: ETFs are available for nearly every asset class, including equities, fixed income, commodities, and foreign exchange markets.
•Diversification: ETFs provide exposure to an entire asset class or sector, reducing idiosyncratic risk.