The really big news is the reformulation of Arete’s investment strategy continues apace. As a result, this report will reflect a number of the changes. In preview, the portfolios remain unchanged from last quarter, but I will lay out the roadmap for how I expect them to change. The new name for the strategy, All Terrain, captures the essence of these changes.
One of the key characteristics that will remain the same is cash will be used strategically to avoid excessive risk and to provide a valuable option to buy attractive assets at a cheaper price in the future. Since nearly all asset prices are inflated right now, I expect cash to remain at higher than targeted levels.
One of the key characteristics that will change is the breadth and type of securities held in portfolios. Most importantly, this will now include mutual funds and exchange-traded funds (ETFs) in addition to common stocks.
This should produce a number of desirable effects. One is the portfolio will be more diversified than it has been in the past. Another is the universe of potential holdings will be much larger which will create new opportunities for accessing various exposures. Yet another is it will facilitate a faster response time when macroeconomic or market conditions change suddenly.
The foundation of the approach will be a conventional allocation of stocks, bonds, and cash. Because the investment environment is especially risky for stocks and bonds, however, the most notable aspect of the allocation will be the inclusion of two new asset “classes”. These are designed to harvest returns that are either uncorrelated with the market or inversely correlated. I have assigned them the labels of “Nonmarket” and “Positive convexity”. I should also mention “Gold” will also be considered its own asset class due to its unique characteristics through history.
This approach is designed to produce a number of important incremental benefits relative to the Mid Cap Core strategy.
One is there will be a lot more opportunities to gain exposure to unique return opportunities. Another is the portfolio will be much more diversified which should provide more protection against negative market events. As a result of having more downside protection, it will be easier to accept risk in certain areas as well.
At the same time, the strategy will still have the capacity to invest in attractive stocks whenever and to whatever extent those opportunities arise.
Before I wrap up, it makes sense to to revisit the catalyst for these changes. Notably, the ongoing migration to passive investing combined with persistent central bank intervention since the financial crisis has meaningfully altered the distribution and timing of investment returns. In doing so, these forces have transferred a great deal of idiosyncratic risk to systemic risk. This is a subject I broached in the market review for the second quarter.
The most notable effect from these changes has been to vastly undermine the potential to generate outsized returns through security selection, at least in the short- to intermediate term. Unfortunately, this was a major premise upon which the Areté Mid Cap Core strategy was based.
The good news is the vast major of Areté’s investment philosophy and founding principles still hold. I still think it is important to help investors get the most out of their experience with investing and there are still enormous opportunities to create a portfolio of uncorrelated assets. Further, when the carry regime finally does end, there will again be incredible opportunities for stock picking.
I said it last quarter and I’ll say it again: I am both excited and anxious about these changes. While I still hate to “quit” the midcap strategy, the investment landscape has changed and we need to adapt. I still believe there is a lot of risk in overvalued markets, but I am encouraged by the prospect of being able to do more about it.
As always, thanks for your support!
David Robertson, CFA
CEO, Portfolio Manager