Corey Hoffstein - “Risk Cannot Be Destroyed, Only Transformed" | #68

Episode Summary

Executive Summary: Corey Hofstein explains Newfound Research’s quantitative-behavioral approach to investing: build portfolios from risk first, not return forecasts; recognize that U.S. stocks and bonds are richly valued; diversify into cheaper, higher expected-return assets; and design implementations investors can actually stick with. The conversation emphasizes humility, the importance of drawdown tolerance, and why underperformance cycles are inevitable for any strategy that aims to outperform long term.

Main Topics: Newfound’s origin and evolution (Priority: 4/5): Hofstein describes founding Newfound in 2008 during the financial crisis, initially as a side project selling tactical portfolio data and later expanding into sub-advisory, funds, and separate accounts focused on quantitative tactical asset allocation. Quantitative + behavioral investing framework (Priority: 5/5): Newfound’s philosophy combines systematic portfolio construction with behavioral realism: portfolios must be not only optimal on paper, but also survivable for investors through drawdowns and long holding periods. Why current U.S. stocks and bonds look unattractive (Priority: 5/5): The discussion argues that today’s valuations and yields imply lower future returns for traditional U.S. 60/40 portfolios, making a broad diversification away from U.S. equities and core bonds more compelling. Portfolio construction across asset classes (Priority: 5/5): Hofstein outlines how an optimizer, using published capital market assumptions, often favors emerging markets, alternatives like managed futures, and credit-heavy allocations over U.S. stocks and aggregate bonds. Timing luck, trend signals, and implementation details (Priority: 4/5): Small implementation choices—rebalance timing, signal length, dollar-cost averaging into and out of signals—can materially affect outcomes, especially in tactical and trend-following strategies. Managing underperformance and investor expectations (Priority: 5/5): The conversation stresses that any strategy with long-term edge must endure periods of painful underperformance; Buffett is used as the canonical example of why permanent capital and patience matter. Research frontiers: multi-asset factors and cross-asset value (Priority: 4/5): Hofstein’s current research focus is on applying value, momentum, carry, defensive, and trend concepts across multiple asset classes while controlling for portfolio risk and diversification tradeoffs.

Key Arguments: Risk, not return, is the correct foundation for portfolio design; returns are byproducts of how risk is identified, transferred, and transformed. A good portfolio is one investors can actually hold through adversity; behavioral stickiness may matter as much as mathematical optimality. U.S. equities and bonds are both expensive/low-yielding relative to history, so expected forward returns for a traditional 60/40 are likely muted. If you optimize using capital market assumptions without label bias, the resulting portfolio can look very different from conventional allocations: little U.S. equity, little core bond exposure, more EM, managed futures, credit, and long Treasuries. Tactical investing should not be defined as a single universal rule; it can range from a completion sleeve to a whole-client solution depending on investor needs. Trend-following and other timing strategies are sensitive to implementation details like rebalance frequency and signal design, creating 'timing luck' that can materially change results. Underperformance is not evidence that a strategy is broken; it is often the price of having a true edge, because crowded strategies eventually lose their advantage. Cross-asset valuation timing is hard because valuation metrics differ by asset class and risk profiles differ materially; therefore, multi-asset signals must be integrated carefully into portfolio construction. Dividend yield is often just low-quality value in disguise, while dividend growth may be more related to quality/profitability than pure yield chasing. Cash can be a useful behavioral and portfolio-construction tool, not merely 'idle' capital, because it provides optionality and can support riskier sleeves elsewhere.

Data Points: Newfound founding date: August 2008 - Hofstein says the firm started at the depths of the financial crisis. Firm age at time of interview: About 9 years - He notes Newfound is nearing its nine-year birthday. Current valuation level for U.S. equities: North of 30 on CAPE-like measures - Used to argue that expected equity returns are below historical averages. Barclays Aggregate duration: Around 5.5 - Example used in the bond-return rule of thumb. Bond return rule of thumb: Two times duration minus one - Applied to estimate 10-year bond returns from current yield and duration. Barclays Aggregate current yield: About 2.5% to 2.75% - Used to illustrate low future expected nominal returns for core bonds. Expected return drag from rising rates concern: Only a few 50-70 bps per year historically from declining rates - Hofstein argues coupons were the dominant driver of bond returns, not rate declines. Optimizer-implied equity exposure: Almost none in U.S. equities - From a mean-variance optimization using published capital market assumptions. Optimizer-implied fixed income exposure: Almost none in traditional U.S. fixed income - The same optimization favored other assets over aggregate bonds. Optimizer-favored sleeves: Emerging markets, managed futures, credit, REITs, and long Treasuries - Examples of assets that could comprise a large part of the optimized portfolio. Typical allocation weight to these sleeves: About 30% to 50% of the portfolio - Hofstein says these assets could dominate an optimized moderate-risk portfolio. Behavioral 'give-up' for making the portfolio more conventional: About 50 to 100 bps of return - Estimated cost of reintroducing meaningful U.S. equity and aggregate bond exposure for client acceptability. Managed futures allocation from optimizer: About 5% to 15% - Illustrative allocation range in optimized portfolios. Long Treasuries allocation from optimizer: About 10% to 15% - Used in the example of a barbelled risk portfolio. Weekly commentary cadence: Mondays at 10 a.m. Eastern - Hofstein mentions his regular published research schedule. Research output: Around 150 weekly pieces - He cites the breadth of his published writing history. Buffett’s worst relative one-year underperformance: 50% to 60% worse than the S&P 500 - Example used to show that even great strategies can endure severe underperformance.

Pivotal Quotes: "hubris tends to sell, but humility tends to survive" — Corey Hofstein: Explaining Newfound’s philosophical stance on investing and research. "risk cannot be destroyed, only transformed" — Corey Hofstein: A foundational principle Hofstein says underpins portfolio design and finance more broadly. "the journey [is] just as important as the destination" — Corey Hofstein: Describing why investor behavior and drawdown tolerance are central to portfolio construction.

Implications: Listeners should expect lower returns from traditional U.S. stocks and bonds and consider broader diversification, but only in ways they can psychologically and operationally stick with. The industry’s next edge may come from combining rigorous risk modeling with investor-friendly implementation.