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Designing The Strategy - Audio Clip

Eric shares his experience researching and building investment strategies and some of the surprises he ran into along the way.

Key Takeways

One of Eric's projects was to build a full bells and whistles investment strategy, which in a backtest had very impressive performance.
However, Standpoint realized that this approach to strategy design was too fragile. Adding too many features to an investment approach decays the validity of that system.
Keeping your investment strategy simple reduces the probability of unknown risks and creates an environment for investors to stay disciplined more easily.

Transcript

Eric: During the evolution of our research at Standpoint, I took two years off and was able to not be a part of the markets for two years. And looking back I would say that was a game-changer for me. Having no pressure and deadlines and having the ability to go back into a research environment with all the knowledge that I’ve accumulated over the preceding 22 years and reevaluate how much of that’s really wisdom and how much of that is just knowledge. Then put your ego aside and really question your assumptions and what you think you’ve learned.

During that two-year period, I built what I thought would be the full featured global macro strategy that everyone would love, no one would complain about. Even my peers in the industry would say that’s really awesome, it has everything, all these risk balancing things, and it has machine learning and AI, it’s beta neutral, and it’s equal risk contribution; or at least has the ability to do those things. So every buzz word, every feature that you’re going to hear on Wall Street.

I built those things and I realized that I’m not going to invest in this thing because it has too many moving parts, it’s too fragile. It looks elegant and beautiful, but I guess deep down inside I really don’t trust all these features.

I took all the research I was doing and I took all the features and I sorted them from least important to most important and I started removing them one at a time. This is what I mean when I say this was a humbling experience. I started removing these things that seem so important, but they make almost no difference. For 50 years you can’t notice a difference as I remove them.

I remove them and rerun the analysis and I’m like, well that contributed almost nothing. And I kept going and going and going. Some of them, by removing them the results got better.

That doesn’t appeal to a lot of people. A lot of us have what we call a complexity fetish where we think the more information the better, the more filters and rules. But those of us in the industry, if you analyze the survivors in this industry, and talk to them off the record, I think most of them would admit that there are two or three things that you have to do really well. They’re simple, but they’re not easy.

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