Season Investments

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The Tortoise or the Hare

Posted on February 11, 2014

“The first rule of investing is don’t lose money; the second rule is don’t forget rule number one” - Warren Buffett

As the Oracle of Omaha so aptly stated in the opening quote, the most important part of investing is managing risk in order to not lose money.  One of the ways we try to do this is through our Diversification 2.0 portfolio construction which breaks the investment universe down into five asset classes: stocks, bonds, commodities, currencies, and absolute return strategies. Technically speaking, our five asset classes are really made up of four distinct asset types and one investment style that utilizes any/all of those assets to generate an uncorrelated stream of absolute returns.

All financial assets fall into one of four categories: equity (stocks), debt (bonds), currency (cash), or hard assets (commodities). Think of a typical real estate transaction which actually encompasses all four of these assets. The house is a hard asset which acts as collateral for the bank which creates debt by extending credit to the buyer so that the seller can receive payment in the form of cash for the house. Lastly, the buyer’s down payment creates an equity position (asset value – debt) in the house for the new homeowner.

So where does absolute return fit into the mix? As mentioned earlier, absolute return is a style of investing that utilizes the four asset classes in a way that generates an uncorrelated return stream. We have touched upon, if not beaten to death, the topic of correlation in previous posts so we will try not to spend too much time unpacking its importance here. The key takeaway is that diversification cannot be achieved with a mix of highly correlated assets. When investments are uncorrelated it means that some might be zigging while others are zagging. Correlation is measured on a scale of -100% to 100% with negative values indicating inverse correlation, positive values measuring positive correlation, and values closest to zero indicating the return streams are uncorrelated (moving independently of each other). The more investments with uncorrelated return streams that have the potential to make money over time, the more a portfolio is diversified against losses. The embedded table, which we’ve shown in the past, shows how the five asset classes in our portfolios correlate with each other.  

2013-02-12_Asset_Classes_Correlation.png

From the table we can see that absolute return strategies have low levels of correlation to any of the other four asset types. This is the key reason why we include absolute return in our portfolio mix. Even though absolute return strategies utilize a combination of the other four asset types in their strategy, they do it in such a way as to still produce somewhat independent return streams. The classic example we like to use to explain this is a “market neutral” strategy like the one we hold being run by Causeway Capital Management which we profiled in our post Value Investors & Quants Unite. Market neutrality is achieved by going both long and short different investments within an asset class.

As an example, let’s say an investor was really bullish on the future prospects of Coca Cola but was worried about outside factors/risks that might influence the soft drink industry (e.g. rising labor or material costs) or the stock market as a whole (e.g. recession, terrorist attack, etc.). If they felt that Coke was the best of breed then they could take a long position in the stock and pair it with a short position in a competitor like Pepsi or a basket of soft drink companies. By doing this, the investor has created a unique return stream which is driven by the difference (spread) in the return of Coca Cola versus the short holdings. The spread is not dependent on a rising stock market as the only thing that matters is that Coke outperforms the short holdings. In a rising market, it needs to go up by more than the shorts to make money. In a falling market, it needs to fall less than the shorts to make money. This return stream has little to no correlation with the stock market as a whole even though the underlying investments are in stocks.

Absolute return is a widely used phrase that can carry a variety of meanings. For us, it means a strategy that has an embedded risk management process with the ability to generate uncorrelated returns to the other four asset classes. Risk management is the key to Buffett’s first rule of investing and something we take very seriously. The goal of our Absolute Return allocation is to “hit singles and doubles” in any market environment. In this way, absolute return strategies are much more akin to the tortoise rather than the hare in the classic Aesop’s Fable. As everyone knows, even though there were long stretches of time where the tortoise was losing to the hare, the tortoise’s slow and persistent progress ultimately won him the race. 


elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.


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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.