Investment Thesis for 2019

Here are my ideas that are guiding personal investments, as well as macro views. I've noted where I have skin in the game with current positioning, which may be useful to project my relative confidence.

You'll notice that I have an active portfolio, while I recommend that others stick to as boring-as-possible three-fund or inexpensive target-retirement portfolios. Later, I'll write about why I structure investments this way, but it very well may be a "do as I say, not as I do" position.

Public markets

US Equities are not likely topping

Position: 40% of portfolio is in US equities using a tactical asset allocation timing model[1] that underperformed in 2018.

The past year has been tepid in US public markets, with a marked increase in volatility. However, larger economic signals and timing models (such as Philosophical Economics's Growth Trend Timing model) do not yet indicate a recession is looming. To be fair, it certainly could be still, and many tactical asset allocation models underperformed during the past year due to volatility spikes. However, I don't see enough to reduce beta exposure just yet, even if we're late cycle.

Near term volatility is overpriced, tail event volatility is underpriced

Position: Partial US equities hedge using a small position of far-OTM put back spreads, target net drain of <1% on portfolio per year.

After the volatility blowup in February, being short volatility, in general, has been a difficult trade. However, I believe that short-term volatility will fall during the next year. Concurrently, tail event volatility continues to be underpriced due to unlikely but present risks stemming from the US foreign policy.

Recovery of commodity trend following futures programs

Position: 15% of my portfolio trades a futures trend following model[2]. It has underperformed in the past two years, and I am not changing its allocation right now.

Trend following CTA funds have performed poorly recently. My assumption is that we're nearing max pain for this trade, and due to momentum's long term alpha, I believe we will see at least a partial recovery of these funds.

Public market quant alpha remains difficult to extract

Position: A short-term quant strategy that I've run for the past couple years, representing roughly 10% of my portfolio.

Unless you're RenTech, public markets will remain largely efficient and easy to extract quant alpha will remain scarce. As fewer humans control portfolio allocation, and quantitative strategies can scale easily, it'll remain difficult for retail investors to outperform.

Due to an allocation strategy similar to Hierarchical Risk Parity that I use, I continue to keep exposure to my own strategy, which performs particularly well as many tactical asset allocation strategies struggle.

Private markets

Rise of Micro-Private Equity

Position: Total 10% of portfolio invested in Earnest Capital (a new "funding for bootstrappers" fund; public thesis) and minority stakes in a few small niche SaaS companies. No expectation of markups or liquidity during the next year.

Cheap capital continues to chase venture and private equity to meet return obligations. At the same time,

  1. It's becoming easier to found small businesses, with minimal CapEx needed.
  2. More established businesses are for sale, as founders are retiring or cashing out.
  3. Operational experience is the most difficult asset to commoditize.

My assumption is that PE remains overpriced, but micro-PE (as performed by funds such as, Chenmark Capital, etc) should continue to see outperformance. Since supply is high and capital is cheap, know-how into acquisitions and operations is the limiting factor, and is the most difficult for larger PE firms to replicate. This is an area that I'd like to learn more about.

Unicorns will IPO

Position: None

We're nearing 10 years since the bottom of the economic cycle, and many unicorns will be seeking liquidity. Recent valuations seem high to me, though these companies may be appropriately positioned to continue innovating. I have no convictions in this area.

Early stage startups will have high valuations

Position: Very small angel positions in several startups

In alignment with my micro-PE thesis, I believe it's getting easier and easier to found companies and address smaller market needs. Since capital it cheap, again, the shortage is on operational experience. So, I would expect that we'll see a continued rise in early stage valuations. This is difficult to trade, but I think there's case where early stage startups previously were undervalued.

The testable prediction is that the two YC batches should have no issues raising rounds, and the rounds will be priced higher than was common before.

Other alternatives

Litigation finance continues outsized returns

Position: Several opportunistic positions through LexShares, will deploy from cash as cases are available.

I believe large companies have underpriced tail risk from litigation and regulatory blowback from excess unrealized externalities. As such, I expect juries to continue awarding large punitive damages to plaintiffs, and plaintiffs will continue to seek early liquidity. As with micro-PE, deploying large amounts of capital is difficult, so I expect to see outsized returns here.

Interestingly, I've noticed that LexShares cases fill quickly, often within minutes. This means there is already a lot of capital interest, and longer term, incentives may lower the threshold for case quality.

Bitcoin struggles to find a mainstream use-case, high volatility expected

Position: ~3% of portfolio in BTC / ETH, size largely by accident (unrealized historical gains). Low conviction.

2018 was a horrible year for cryptocurrencies, and if they recover, we're solidly in the "crypto winter". I don't see any significant reasons why it would be over in 2019, but with an 80% drawdown from peak, I wouldn't be surprised if there's some sort of recovery. But I don't have strong conviction here, largely because the macro case isn't proven: it's technology in search of a market.

Naively, I would expect Bitcoin to outperform other coins in general due to brand strength.

Due to my employment, I also have a large future-implied position in Google, not included in the above allocations. I'm ambivalent about its future financial returns, and typically sell at the vesting price when I'm able to.

  1. I use a strategy similar to Allocate Smartly's Meta Strategy. If you're interested in active public market strategies, I recommend them strongly due to their quality of backtests. ↩︎

  2. My specific strategy is a volatility-adjusted trend following strategy, built from concepts from Clenow, Carver, Oxford Capital Strategies, and de Prado. ↩︎

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