Corey Hoffstein, Co-Founder and CIO of Newfound Research, is revolutionizing investment strategies for high-net-worth clients. He discusses the challenges of diversifying beyond traditional stocks and bonds, introducing innovative concepts like return stacking through ETFs. Corey compares risk characteristics of corporate bonds with merger arbitrage, revealing lower correlations with equities. He also shares insights on trend-following strategies and their defensive qualities during market downturns, shedding light on persistent risk premiums for savvy investors.
High net worth investors are diversifying beyond traditional allocations due to changing market conditions impacting risk and return management.
Newfound Research's return stacking method layers alternative risk premium strategies over traditional investments, addressing both mathematical and behavioral challenges faced by advisors.
Trend following strategies provide essential defensive positioning in market downturns, but their effectiveness varies significantly among different managers, underscoring the need for careful strategy selection.
Deep dives
The Need for Diversification in High Net Worth Portfolios
High net worth investors are increasingly recognizing the need to diversify beyond traditional 60-40 stock and bond allocations. This shift comes in response to a changing market landscape where reliance on conventional equity and fixed income strategies may no longer suffice for risk management and return generation. Newfound Research’s innovative approach, termed return stacking, allows investors to maintain their core stock and bond exposures while adding alternative sources of risk premium through ETFs. This strategy not only preserves the mathematical integrity of the portfolio but also addresses behavioral challenges that arise when introducing new asset classes.
Understanding Return Stacking and Its Advantages
Return stacking is a method that combines traditional stock and bond exposure with alternative asset strategies, effectively layering their returns without sacrificing the core portfolio. This innovative approach aims to solve two primary problems faced by advisors: the mathematical challenge of adjusting asset allocations and the behavioral friction encountered when clients resist shifting away from familiar investments. By packaging diversifiers into a single ticker solution, investors can integrate alternatives seamlessly, thereby enhancing their portfolios. The rapid growth in assets under management for return stacking products reflects their effectiveness in addressing these contemporary investment challenges.
The Impact of Trend Following Strategies
Trend following strategies are designed to capitalize on the momentum of market movements by taking long or short positions based on asset price trends. These strategies can be instrumental in providing defensive positioning during market downturns; however, their effectiveness can vary significantly among different managers. Recent market conditions highlighted a dispersion in performance, as some trend following strategies were lagging during early drawdowns in the S&P 500. The variability among trend managers reinforces the importance of selecting strategies that respond appropriately to contemporary market dynamics while managing risks effectively.
Risk Premium Comparison: Corporate Bonds vs. Merger Arbitrage
A recent exploration into the inherent risk characteristics between corporate bonds and merger arbitrage reveals distinct differences in their correlation to equity market risks. Merger arbitrage strategies, which capitalize on the price spread of acquiring company stocks, historically offer attractive returns while exhibiting lower correlation to traditional stocks and bonds. Despite tight corporate bond spreads and potential underperformance from active managers versus beta, merger arbitrage remains a compelling alternative for risk compensation. Implementing corporate bonds as a base, stacking merger arbitrage adds layers of diversification without shifting the core portfolio significantly.
Innovations in the ETF Landscape
Recent regulatory changes, such as the ETF rule and the 18F4 derivatives rule, have spurred innovation in the active ETF space, allowing boutique firms to launch more sophisticated strategies. These developments are critical as they provide clearer guidelines for utilizing derivatives in funds, making it easier for smaller players to enter the market and diversify investment offerings. Additionally, the need for market makers to effectively price complex products has driven improvements in the overall ETF ecosystem. The ability to differentiate emerging strategies that promise better risk premium will continue to facilitate growth and innovation in investment products.
Corey Hoffstein, the Co-Founder and CIO of Newfound Research is among the investors expanding the financial product set available to the RIA community. A client segment that has long been fed a diet of 60/40 exposures, the high-net-worth community is finding the need to diversify beyond stock and bond exposure. Using their innovative approach to return stacking, Corey and team are making alternative sources of risk premium accessible and packaged in an ETF format.
Through our conversation, we first learn that from a behavioral standpoint, introducing entirely new securities with new exposures has been a challenging ask. With return stacking, the diversifying strategy is put on top of an existing stock or bond exposure, packaged in one security. We discuss Corey’s recent white paper, comparing the risk characteristics of corporate bonds to that of merger arbitrage and how each exposure interacts with stock and bond markets. He finds the correlation of risk arbitrage returns to those of the equity market are lower than corporate bond spreads to equities.
We also review a realm of trading strategies that Corey has focused on substantially over the years, trend following. He walks through the manner in which trend can be defensive and how it behaved specifically over this recent significant market drawdown. We finish by getting some of Corey’s thoughts on the broad topic of risk premiums and which like merger arb and vol selling ought to be persistent sources of compensation.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Corey Hoffstein.
Remember Everything You Learn from Podcasts
Save insights instantly, chat with episodes, and build lasting knowledge - all powered by AI.
