Cole Wilcox on The Power Law of Investing | #584

Episode Summary

Executive Summary: Cole Wilcox of Longboard Asset Management explains how trend-following can be applied to individual U.S. stocks using a long/flat framework: buy stocks making new highs, exit with disciplined stops, and hold T-bills when trends break. He argues this approach captures power-law winners, improves tax efficiency, lowers drawdowns versus equity beta, and offers a diversifying alternative to multi-asset managed futures.

Main Topics: Defining trend-following on stocks: Wilcox frames trend as any rules-based process that goes with the market, uses an entry and exit, and manages risk with discipline rather than prediction. The 2005 research and its update: He reviews the original paper on trend-following in individual stocks and the related 'capitalism distribution' work, then explains the newer update showing the idea still works across a much larger dataset. Long/flat versus long-only vs multi-asset trend: The strategy is implemented as long stocks or T-bills, not long-short futures. That makes it more equity-like in strong markets but still defensive in crises, with different tradeoffs than traditional managed futures. Power laws and concentration of returns: A tiny fraction of trades and stocks generate most of the gains. The strategy is designed to stay exposed to rare super-winners while cutting losers early. Portfolio construction and implementation: The fund screens a broad U.S. universe, typically owns only a minority of names, recalculates daily, and uses no sector caps, allowing meaningful active bets and concentration in strongest trends. Behavioral and tax advantages: Trend can help investors avoid catastrophic losses, stay invested in major winners, and harvest losses while deferring gains, making it more tax-efficient than futures-based trend. Current market conditions and practical use cases: Wilcox discusses how the strategy has been reducing risk in 2025, why it belongs in an alternatives sleeve, and how it complements other diversifiers rather than replacing equity beta.

Key Arguments: Trend is best understood as a disciplined, rules-based way of not fighting the market; success depends on having exits and being willing to be wrong. The biggest investment returns come from a very small number of winners, so a strategy must stay exposed long enough to capture them. Stock trend-following on U.S. equities can work because American capitalism repeatedly produces extreme winners and periodic busts that reward defensive risk management. A long/flat stock trend strategy can deliver equity-like upside with lower drawdowns, lower volatility, lower beta, and lower correlation than the market. Compared with multi-asset managed futures, stock trend-following gives up some crisis correlation benefits but is typically more consistent and higher-return over rolling periods. Market-cap indexing is described as a slow, naive form of trend-following because it naturally allocates more to what has worked and less to what has not. The strategy is tax-efficient because losses are realized more often than gains, while long-term winners can compound for years before exit. For discretionary investors, simple stops can improve decision-making by preventing catastrophic losses and emotional attachment to losers. The strategy works best in an alt sleeve or alongside other trend managers, not as a direct replacement for equity beta due to its moderate correlation and different universe. The update suggests the concept still works over decades of U.S. stock data, validating the original thesis at larger scale.

Data Points: Original paper publication: 2005 - Wilcox says the original trend-following-on-stocks work was published about 20 years ago. Backtest horizon in updated paper: Back to the 1950s - The updated study extends the data set much further back than the original paper. Trades tested in updated backtest: About 60,000 - He says the newer paper used roughly 60,000 trades over the extended sample. Profitable trade share: About 44% win rate / 56% losers - Wilcox states the strategy loses on roughly 56% of trades, emphasizing asymmetry over batting average. Trades responsible for gains: 7% of trades produced 100% of total gains - He highlights the power-law nature of returns in the stock trend strategy. Correlation to multi-asset trend: 0.29 - He says the stock-trend fund has low correlation to traditional multi-asset managed futures. Average universe coverage: 20% to 25% owned - He says the portfolio typically holds about 400 to 800 names out of the Russell 2500 universe. Potential holdings count: 400 to 800 stocks - This is the approximate range of names the strategy can hold depending on breadth and conditions. Portfolio risk mix in 2025 example: About 90% equities / 10% T-bills moving toward 50% T-bills / 50% equities - He describes how the strategy reduced risk as market trends weakened in 2025. Holding period for winners: Measured in years - He says the most profitable positions tend to be held for years. Holding period for losers: About six months - Losers are cut relatively quickly compared with winners. Managed futures benchmark referenced: SG Trend Index - Wilcox says this is the best benchmark proxy for diversified managed futures exposure. Mutual fund survival statistic: About half fail or merge away before year seven - He cites industry fund mortality to highlight how difficult it is for differentiated strategies to survive. Historical best stock gain example: 265,528,901% - He references the best-performing stock of all time, Philip Morris/Altria, over a very long history. Bitcoin example price: $107,000 to $108,000 all-time high range - Used as an example of buying new highs with a trend-following discipline.

Pivotal Quotes: "You have to be a very good loser to be successful as a trend follower." — Cole Wilcox: He explains that trend-following requires accepting frequent small losses to capture rare big winners. "Market cap indexes are trend-following. I would just call them very slow-moving trend-following strategies." — Cole Wilcox: He argues passive indexation naturally increases exposure to recent winners over time. "It does very well at benefiting from the outcome of this American system of capitalism, but at the same time is realistic and pragmatic about the risks associated with that." — Cole Wilcox: He summarizes why U.S. stock trend-following is, in his view, structurally durable.

Implications: For investors, the lesson is to favor disciplined exits, stay open to rare winners, and use stock trend-following as a diversifying alt sleeve rather than a market replacement. The approach may be especially valuable for taxes, behavior, and crisis resilience.