The following is an excerpt of ValueWalk’s interview with Corey Hoffstein, CIO and Co-Founder at Newfound Research, which can be found in full on ValueWalk Premium. We ask Corey to define tracking error and how he utilizes them.
Q4 2019 hedge fund letters, conferences and more
All right, yeah. on your site. There's a quote that I really like it's we offer high conviction systematically manage tactical allocation strategies. What does that mean?
It's a mouthful, for sure. So I used to walk your piecemeal so and I think I'll start back to selling it. So tactical allocation strategy, really our investment strategy at 10 to make relative investment decision at the asset class level is your geographic level. So for me, the country or region, often the sector level, and nowadays even sort of factor level, you might tilt towards value or tilt towards momentum. But the difference being that you tend to not make decisions that with the security level necessarily, so the signals that we're looking at might tell us to be in bond versus thought, but I'm just going to buy a basket of stocks, I'm not going to try to pick the individual, you know, one or two stocks that I think are the best buy at that time. And so that tends to be what tactical asset allocation is about. You mentioned systematically manage, so as a firm again, going back to my DNA and the DNA of everyone else at the firm, we're 100% quantitative, so there's no discretionary intervention. Everything we do is completely systematised. We use computer models to generate quantitative signals that drive the changes in our portfolios. And then, to that point of high conviction, we tend at a firm to be willing to make very large practical changes, with little concern for traditional measures of tracking or any sort of benchmark. And we really let our models always guide us into those positions with the idea of basically being that investors want to incorporate our strategies, they can really get the most bang for their buck, if we're willing to take on a lot of that sort of risk ourselves, in the sense of those high tracking error strategies tend to have more career risk associated with them. So we're willing to take that career risk if we're willing to make those big tactical changes, and allows an investor to allocate a smaller portion of their capital to have a meaningful impact on the type of return or risk management that they're pursuing.
Yeah, can tell me more about the tracking error and first, I guess, if you can provide like a basic definition and how you utilise that?
Yeah, absolutely. So tracking her in the industry is typically measure against the benchmark. So it's going to be how much does your strategy tend to deviate your strategies return deviate from that benchmark. And if you look on the institutional side, when institutions like retirement system are putting out a request, or different tactical mandates, they typically benchmarking for something like a 60/40 Global 60% thoughts for fixed income. And the tracking error range will normally be between call it 3% and 5% annualised and so what they would expect then is sort of if you think of that in standard deviations, your returns shouldn't be centred around the 6040 but might be with in a given year, plus or minus, you know, 510 at the 315 percent. And so there is obviously a tremendous amount of wiggle room there. But there is this expectation that you are ultimately centred around that 60/40. We very frequently just forego that, and say we just want to be based on our models positions, wherever we think the best place to be is, without much regard to what sort of the standard benchmark is only because if someone has benchmark century, they can always dilute our portfolios, they always buy a little less of us a little bit more of a benchmark, and construct that tracking error themselves. So for me to deliver that. dilute myself ultimately means that the opportunity for me to deliver differentiated returns is diluted so I'd rather deliver the and diluted service and let people then mix and match as they teach it for their to custom tailored to their specific needs.
