New Discoveries and Portfolio Elements

Friday, April 8th, 2016
By Steve Wruble, CIO, RiskX Investments

Portfolio theory has had significant breakthroughs in recent times. Remember when your smart-beta ETF didn’t work so well in the ‘70’s? Or the high-frequency trading effect of 1986? Neither does anyone else. Mostly because those strategies were developed in much more recent history. Largely influenced by technology, the dynamics of an ever-evolving market, and many aspects of science, we continue to expand the scope of investment theory and identify new factors that influence portfolios.

In the realm of scientific discoveries, something astounding happened recently. Four new elements were added to the Periodic Table in December last year. The previous newest element was added in 2011, after averaging one new element a year since 1863 when Mendeleev codified the first 56. Almost five years later, four have been added simultaneously.

Many of the new elements with a high atomic number (like the four new additions) are the products of technological development. Plutonium doesn’t grow on trees—nearly two dozen elements have been created artificially in nuclear reactors or particle accelerators. This is another broad example of scientific and technological evolution creating a new way to do things.

A quote stood out to me from the new elements press release:

It seems certain that by using similar nuclear fusion reactions, proceeding beyond element 118 will be more difficult than reaching it. But that was the feeling after the discovery of element 112, first observed in 1996. And yet a new approach using Ca-48 projectiles allowed another six elements to be discovered.

Full article at: The race to find even more new elements to add to the periodic table 1

Like with the Periodic Table, improvements in technology help us define new elements of portfolio theory that were previously unknown—even factors that seemed near impossible to identify. To our minds, volatility is something we experience and can see after the fact, thus making it unsuitable as a risk target. So instead, we focus on identifying what a portfolio needs in order to survive on a forward-looking basis.

At RiskX, we’ve based our whole research process on the idea that there are things that we know, things that have worked or not worked, and things that we haven’t learned yet. Much of our portfolio research is actually based on the concept of elements—the lowest point of unique existence identified by the fact that they cannot be broken down further.

We examine the universe of money managers, investment strategies and strategists, and investment products, and aim to break them down to their basic “elements.” In other words, what makes them work in certain market conditions and not necessarily in others. It’s been our continued mission to build a system that not only disassembles the world of tactical investment strategies down to their unique parts, but also re-assemble combinations of investment strategies into diversified portfolios.

Aluminum by itself has the problem of being too malleable in certain environments, so alloys are created by incorporating other elements like magnesium, silicon and zinc. Like physical elements and compounds, different investment strategies can be stable or volatile depending on their design and their reaction to certain market conditions. We view the diversification of investment strategies as our way of creating a purposeful, “compound” portfolio.

Strategic beta, or purely passive investing, is a strategy where, in our view, the key active elements are a long time horizon, factor anomalies, and efficient markets. However, those elements alone don’t address short-term volatility, drawdown risk, or loss aversion. To achieve our view of diversification, we incorporate tactical investment strategies with elements that shift between ‘states’ depending on the environment. We also look to incorporate complimentary elements from additional active managers who have proven value-add.

Each of the investment strategies added to a portfolio should act as a diversifier, and technology now allows us to view their interaction. The benefit is that these portfolios are diversified with exposure to an optimal mix of investment strategies, each expected to have favorable and unfavorable market conditions. We think of this as portfolios that prepare for possible future environments and have the tools necessary to survive, rather than attempting to predict what will happen.

What we propose isn’t radical. We believe creating an effective portfolio for clients with a behaviorally-influenced, non-institutional, time horizon requires us to use many of the strategies that we are aware of, both old and recent. However, we acknowledge and anticipate that there are investment strategies no one even knows about yet which could become an important part of a diversified portfolio, and our job is to discover and research them. Thus, just as our portfolios adapt to changing markets, we adapt to an evolving investment environment.

It’s pretty logical that portfolios need old-school, inexpensive, strategic beta, but can also be enhanced by some of the new methods of achieving “smart” beta. However, a portfolio also needs optimal exposure to tactical strategies that can adapt to events and new developments in the markets. Of equal importance are the methods we use to create optimal and diversified exposures to prepare for whatever investment environment we encounter in the future. We are always happy and able to show you how to incorporate the RiskX philosophy into your process.

1 David Hinde. “The race to find even more new elements to add to the periodic table.” Phys.org, January 5, 2016. http://phys.org/news/2016-01-elements-periodic-table.html. Accessed March 5, 2016.

The views and opinions expressed in this article are for informational purposes only and not for the purpose of providing investment advice, are those of the author as of the date of the article and may differ from those of the firm; and are subject to change over time or at any time. Diversification, the investment and risk mitigation strategies discussed in this article may not be suitable for every investor, do not ensure a profit and cannot protect against losses in a declining market. Investors should review with their advisors the appropriateness of any investment strategy. RiskX Investments LLC makes no guarantees on the completeness or accuracy of information provided herein.

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Investment decisions should be based on an individual’s own goals, time horizon and tolerance for risk. Past performance is no guarantee of future results.

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