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The Better Part of Valor

Posted on August 11, 2015

“The better part of valor is discretion.” – Falstaff in Henry IV

2015-08-11_valor.jpgIn a well-known scene in Shakespeare’s Henry IV we find the cowardly Falstaff lying motionless on the battlefield pretending to be dead. After all his enemies have left the stage Falstaff rises to his feet and justifies his deception by rationalizing that, “The better part of valor is discretion, in the which better part I have saved my life.” While this line was intended to be tongue in cheek, there is certainly some truth to the statement in that courage finds a better companion in caution than in recklessness. We have found this to be true in the world of investing, and our MarketVANE HARD ASSETS strategy has born this truth out very clearly over the past year. 

Just a handful of weeks ago we wrote about the discipline of trend following and our proprietary approach to the discipline via our two MarketVANE models. This post will have a bit of overlap, but will focus in particular on the recent performance of MarketVANE HARD ASSETS and how “discretion” has led to some “valiant” returns over the past thirteen months. But first let’s review what Hard Assets are exactly and why anyone would want to allocate to them in their portfolio. 

According to Wikipedia, “Hard Assets are investments with intrinsic value such as oil, natural gas, gold, silver, farmland, natural colored diamonds and commercial real estate.” These assets are the physical inputs – the raw materials – that are used to create the tangible world around us. In the case of real estate they are the physical structures that we build using the raw materials for the purpose of sheltering some economic activity. 

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Hard assets are attractive additions to an investment portfolio for a number of reasons. First of all, investing in them is expected to produce a positive return. Real estate, for instance, produces a financial return in the form of rental income. Its price can also appreciate over time as supply/demand forces ebb and flow and as the underlying price of the raw inputs (steel, lumber, concrete, etc) increase with inflation. Commodity returns are a bit harder to describe. For the most part commodities are invested in through derivatives (primarily futures contracts) and therefore have three different sources of return: roll yield, collateral yield and spot price appreciation. A detailed discussion of these components is beyond the scope of this post, but suffice it to say that one can reasonably expect to realize positive returns on commodities-related investments over long periods of time. 

Beyond the expectation of positive returns, Hard Assets can exhibit low or even negative correlation to each other and to the stock and bond markets. This means they can add meaningful diversification to an overall portfolio, and might even be a source of positive returns in periods of extreme market stress. For instance, real estate (as measured by an index of real estate investment trusts, or “REITs”) produced a total return of over 25% during the bursting of the tech bubble when stocks were down nearly 50%. Gold, similarly, was up nearly 40% during the global financial crisis when stocks once again got cut in half. By behaving independently of stocks and bonds, Hard Assets can dampen the volatility of returns for a diversified portfolio without necessarily reducing the long-term expected level of those returns. 

For these reasons and others we believe an allocation of some amount to Hard Assets is appropriate for most peoples’ portfolios. That said, let’s talk about a third component of these types of assets: risk. Like stocks, changes in the credit cycle and economic expectations can dramatically change the supply and demand characteristics for these types of assets in financial markets. Thus, both real estate and commodities can exhibit high levels of volatility. Oil, for instance dropped by nearly 80% in the second half of 2008. Gold is down over 40% since September 2011. REITs dropped by over 70% during the subprime crisis. These assets can clearly enter prolonged and pronounced trends in which returns are spectacularly good or bad for periods of several years or more. As such, they are known to be “risky” in their own right, and conventional wisdom suggests that allocation sizes should be relatively small for most investors. 

We would agree with this line of thinking, although we would take it a step further and suggest that the risk these assets possess is large enough that it should be proactively managed. If we believe that Hard Assets will continue to exhibit the tendency to move up and down in large magnitudes over extended periods of time, then it follows that a trend following discipline might be appropriately applied. In The Trend Is Your Friend, we said the following, 

In its simplicity, trend following is an elegant solution to the age old conundrum of wanting (or needing) robust returns while simultaneously being unable to withstand the extreme volatility and drawdowns seen in the market from time to time. Unlike buy-and-hold, a trend following approach uses math to quantify the direction and the strength of the prevailing trend, and based on that analysis determines whether or not to be fully invested, partially invested or even all the way in cash. In doing so, this process offers the investor a built in stop loss against the types of major declines we saw in the bursting of the tech bubble and the financial crisis.

MarketVANE HARD ASSETS is Season Investments’ proprietary trend following strategy applied to Hard Assets. The strategy trades low-cost index ETFs tied to three specific segments: 1) REITs, 2) Gold and 3) Diversified Commodities. By having a mechanism for going to cash when the underlying trend of any of these components breaks down, this strategy gives investors the opportunity to participate in the benefits of investing in Hard Assets while having a stop loss in place to guard against the periods of deep drawdowns. 

We launched a performance composite to track live money results just over a year ago (inception: July 1, 2014). Generally speaking, this period has not been a great one for investing in Hard Assets. Despite REITs being up 11% on a total return basis, gold is down 18% and Commodities are down 28% over the same time period. The chart below shows the path each of these components has taken along the way, and it also depicts when MarketVANE HARD ASSETS has been invested (solid lines) vs sitting in cash (dotted lines). Notice that last September the model exited both Commodities and Gold, and has remained on the sidelines for the majority of the time since. What’s more, the model is currently on a 100% cash signal for the fourth time since the launch of the performance composite.

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We often say that the best offense is a good defense, and in this case playing defense has allowed the MarketVANE HARD ASSETS performance composite to show a loss of only 0.42% since inception vs a loss of 15.74% for its benchmark (equally weighted REITs, Gold, & Diversified Commodities). We obviously want to producing strong positive returns over time, and we are confident that we will, but we are extremely pleased with MarketVANE’s performance on a relative basis thus far.

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By playing defense through a difficult time for this asset class we have been able to preserve capital which will leave us with more dry powder to re-invest when a new bull market emerges in any or all three of the underlying components. This is why, although somewhat counter-intuitive, by being more conservative in this fashion we expect to be able to produce more robust rates of return over time. So maybe Falstaff was on to something all those years ago, and maybe discretion really is the better part of valor. When it comes to investing in risk assets, we certainly think it is.


david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.


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Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.