Investing in exposures that are off the beaten path can lead to natural opportunities, focusing on evaluating the price of uncertainty.
Shift investment approach to finding opportunities regardless of the ability to forecast market movements, recognizing markets' unpredictability.
The Cockroach Portfolio is an all-weather strategy designed to be robust to uncertainty, achieving diversification through equal weighting of various assets.
Deep dives
The Opportunity of Off the Beaten Path Exposures
According to Dylan Greis, co-founder of Calderwood Capital, investing in exposures that are off the beaten path can lead to natural opportunities. Rather than predicting market movements, he focuses on evaluating the price of uncertainty and seeking opportunities to invest with hedge fund managers when the price of risk is favorable. For example, in 2021, Dylan found value in shorting mortgages due to depressed interest rate volatility caused by the belief in transitory inflation. Another area of opportunity is in the reinsurance market, which has seen increased premiums post-Hurricane IDA due to substantial losses. Since catastrophe risk is fundamentally different from market risk, adding exposure to reinsurance can offer low correlation strategies sought by Calderwood.
The Epistemology of Investing
Dylan Greis emphasizes that investing is essentially a study of epistemology—the calibration of what one thinks they know. He believes that genuinely predicting the future is difficult, if not impossible. Instead of making predictions, he focuses on understanding risk management and the psychology of risk-taking. Dylan's career transition from economist to prop trader taught him that volatility and the fear of losses can lead to irrational behavior. Recognizing that markets are often unpredictable, his investment approach shifted to finding investment opportunities regardless of his ability to forecast market movements.
The Cockroach Portfolio: A Zero-Knowledge All-Weather Strategy
Dylan Greis describes the Cockroach Portfolio as an all-weather strategy designed to be robust to uncertainty. The portfolio seeks risk premiums that are fundamentally uncorrelated, ensuring that the portfolio can perform well regardless of the macroeconomic climate. The Cockroach Portfolio achieves its diversification by equal weighting equities, bonds, cash, and gold, which covers various bases such as duration exposure, inflation protection, and diversification between productive and non-productive assets. Dylan believes in avoiding excessive reliance on market predictions and focusing on harvesting real risk premiums in fundamentally uncorrelated strategies.
Opportunities in SPACs and Flat Volatility Surface
Dylan Greis discusses the potential opportunity in Special Purpose Acquisition Companies (SPACs) from an optionality standpoint. He notes that the SPAC market is currently distressed, with many SPACs trading at significant discounts due to reduced deal flow and regulatory concerns. However, the warrants associated with SPACs are still undervalued, and Dylan sees this as a way to gain leverage to a potential future bull market. The low valuations and potential for explosive upside in SPAC warrants make them an attractive addition to a well-diversified portfolio. Furthermore, Dylan highlights the current flat volatility surface, which makes put options more interesting compared to the previous year.
Tail Hedging Performance and Evaluating Risk Premiums
Dylan Greis reflects on the performance of tail hedging in 2022, noting that the flat volatility surface and lack of correlation made hedging strategies less effective. He emphasizes the importance of assessing risk premiums and distinguishing between statistical anomalies and fundamental risk premiums. Dylan believes that fundamental risk premiums exist in areas such as credit risk and catastrophe risk, where investors must be compensated for potential losses. However, he cautions against overpaying for risk premiums and highlights the need to evaluate valuations and market dynamics. Despite the challenges in tail hedging, Dylan suggests that finding real risk premiums and uncorrelated strategies can still offer attractive opportunities.
A "beaten path" refers to a route that is frequently traveled. In markets, for years, this path led investors to be long both stocks and bonds in unison under the premise that duration exposure would mitigate losses during a sell-off in risk assets. In 2022, amidst sharply rising inflation, investors learned painful lessons that stock and bond prices can become highly correlated. For Dylan Grice, Co-founder of Calderwood Capital, the search for exposures that are off the beaten path has always been a natural pursuit.
Originally trained as an economist, Dylan realized early in his career that he was less geared towards making predictions. Instead, his focus is on evaluating the price of uncertainty, looking for opportunities to invest with hedge fund managers that emerge when the price of risk is favorable on either the long or short vol side of the ledger. In his search for cheap optionality, Dylan saw value in being short mortgages in 2021, a time during which interest rate volatility was exceedingly depressed by the forceful promises of the Fed, convinced that inflation was transitory.
He and team have also found opportunities to be well compensated to absorb risk, typically occurring when a market’s capacity to do so has been compromised. Such is the case in the reinsurance market now, where premiums post Hurricane Ida have increased substantially on the back of huge losses suffered. As catastrophe risk is fundamentally unique relative to market risk, adding exposure here is part of the low correlation set of strategies sought by Calderwood.
I hope you enjoy this episode of the Alpha Exchange, my conversation with Dylan Grice. To learn more about Calderwood Capital, please visit www.calderwoodcapital.com.
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