The BCK Volatility Blog

August 2019


August 8, 2019

"The fragile wants tranquility, the antifragile grows from disorder, and the robust doesn't care too much”
- Nassim Taleb, Antifragile: Things that Gain from Disorder

The message above, from former Trader turned Philosopher Nassim Taleb, takes aim at a common course of action in the investing world: when trying to 'beat the market,' most aim to outperform year in and year out. This is, for those outside of Renaissance Technologies' Jim Simons and a few other investing luminaries, a near impossible goal that leaves one exposed to ruin. When attempting to win each year, one will expose themselves to extreme risks that increase the fragility of their portfolio. To beat the market during a strong bull year, a portfolio likely needs to obtain leverage. Leverage increases one's exposure to severe downside risk. An ex-leverage approach to winning each year would likely include increasing the volatility, or exposure to risk, in the portfolio. To us, this is not sustainable in the long-term, so we needed to find another way to approach the timeless problem of 'beating the market.'

The approach we take with the Traditional Asset Strategy is to stay on par with market performance during the good times, maintain neutrality during times of unease and attempt to profit off steep downturns. The neutrality during unease and profiting off downturns phases of the approach lead to long-term outperformance. So, yes, there will be years in which the market performs extremely well while our strategy lags by a small margin. A visual explanation can be seen below:

normal distribution chart

The “normal distribution” makes the claim that the majority of observations will occur within one standard deviation of the mean (the middle). A very small proportion of observations will occur near the tails of the distribution; returns on the right tail being extremely positive and returns on the left tail being extremely negative. Our approach, as evidenced by the visuals below in our Traditional Asset Strategy (note that all data used is taken from live trading performance), is to:

1) take advantage of the upswings in the S&P 500 but avoid the massive drawdowns (this will lead to outperformance)
2) avoid large intraday swings when the S&P 500 is highly volatile (this will lead to fewer observations of daily returns on the right and left tails of the distribution, aka less volatility)

In the long run, we believe the approach will outperform the S&P 500 in total return while experiencing less volatility (aka taking less “risk”).

traditional asset vs S&P 500 chart

The circled areas on the chart above indicate periods in which the S&P 500 (orange) fell rather severely while the Traditional Asset Strategy either maintained relative neutrality or profited. These are the periods in which we will establish our long-term outperformance. The largest drop in the S&P 500 in this timeframe is December 2018. During that month, the S&P 500 had a -20% drawdown while the Traditional Asset Strategy was, at its worst, drawndown -6%. If the subsequent recovery in the market is 20% and the Traditional Asset Strategy takes advantage of only 75% of that recovery, the strategy will still be outperforming. See below:

traditional asset vs S&P 500

To support goal 2), a chart of daily returns of the Traditional Asset Strategy vs. the S&P 500 (SPY) is below. Our goal is to reduce volatility, so we should see fewer observations of daily returns on the right and left tails of the distribution.

traditional asset vs S&P 500 chart 2

As you can see, the daily returns of the S&P 500 (SPY) dominate the tails of the distribution and the daily returns of the Traditional Asset Strategy dominate the area around the mean, suggesting less volatility. Let's revisit the Nassim Taleb quote from earlier: “The fragile wants tranquility, the antifragile grows from disorder, and the robust doesn’t care too much” In relation to outperformance, the Traditional Asset Strategy grows from disorder (aka gains outperformance during times of high volatility) and is robust in relation to market tranquility (aka tracks the market fairly closely during the “good times”). We believe this approach will stand the test of time and will lead to long-term outperformance.