Combining our quantitative market exposure model with our discretionary individual equity selections into a single strategy
The investment process is a two-pronged:
Step #1 - Determine our desired level of market exposure
Getting your market exposure correct will normally be the biggest contributor to your returns. We use a quantitative rules-based model for this process. Our market exposure can range from -50% short up to 150% long. Historically, over 50 years, the model would have been leveraged long approximately 40% of the time and net short approximately 12% of the time.
Step #2 - Stock selection
This is a discretionary process. We have two baskets; one is a basket of long ideas which we expect will outperform the market, and the other is a basket of short ideas which we expect will underperform the market. The weights of each basket are adjusted to reflect our desired level of market exposure from Step #1.
For example, in a $100,000 portfolio, if our market exposure model called for a net long exposure of 25%, our basket of long ideas would contain $25,000 more than our basket of short ideas. This could take any number of combinations, for example, long basket $100,000 and short basket -$75,000; long basket $125,000 and short basket -$100,000; long basket $25,000 and short basket $0, etc.
Proprietary quantitative market exposure model: Market exposure is adjusted based upon a rules-based process validated over fifty years covering multiple economic cycles. It is expected to deliver attractive, uncorrelated returns, particularly during down markets, when diversification most needed.
Reasonably concentrated portfolio: Having 10 to 15 positions in each of our long and short baskets allows detailed due diligence, and research effort required to properly assess and monitor each stock.
Risk management: The maximum individual position size in the long portfolio is 15% and in the short portfolio is 10%.
Simple fee structure: 12% of profits with a high-water-mark test. No asset management fee.
How we differ from traditional hedge fund strategies: Most hedge funds are slightly long-biased or market neutral reflecting their agnostic nature toward the direction of the market - hedge funds are by definition supposed to outperform the market regardless of market direction. Our approach specifically starts with making a call on market direction, and thereafter adds a stock selection component on top of that.