DoubleLine: How to Construct a ‘Better Mousetrap’ Trend-Following Portfolio

Diversification, said economist Harry Markowitz, is the “only free lunch in investing.” Markowitz invented Modern Portfolio Theory, which touts the virtue of diversifying a portfolio, geared to the risk involved.

But just how best to diversify has long been debated. The classic 60-40 mix (stocks and bonds) hasn’t worn too well this year when both asset classes are down.

DoubleLine Capital, celebrated for its fixed-income prowess, has an answer: create an ultra-diversified portfolio that tracks market momentum – best known in Wall Street circles as “trend following” – whether up or down.

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A study from the firm calls for piling 58 different components into the allocation, including all manner of equities (such as small-cap, emerging markets, the S&P 500), fixed income (U.S. Treasuries, Australian government bonds, British ones), commodities (oil, aluminum, gold), and currencies (British, Japanese, European). All are very liquid and have relatively small trading costs.

Together with French bank BNP Paribas, DoubleLine created an index to pack all these elements in together. The index employs strict risk controls to ensure that the portfolio stays in balance and doesn’t tilt too much in one direction. It does this by adding and subtracting leverage, depending on how much volatility a particular asset may encounter.

Known as the BNP Multi-Asset Trend Index, this collection appears to have fared well in recent crises, according to back-testing. Most of the time, it outpaced other alternatives. In the 2008 financial crisis, for instance, it returned 14%, compared with U.S. equities that were riding momentum (8%), presumably by shorting.

Calling the index “a better mousetrap,” meant to capture risk-adjusted returns instead of vermin, two DoubleLine staffers penned the research paper that the concept is based upon.

“By adding a trend-following strategy to a portfolio, investors can increase their diversification while also receiving the opportunity for a positive return,” write Deputy Chief Investment Officer Jeffrey Sherman and Quantitative Analyst Eric Dhall. “This allocation potentially increases the capital efficiency of the portfolio, raising the expected return per unit of risk taken.”

The dynamics of this index maintain what they call “the correlation structure between components.” This approach, they declare, “avoids the pitfall of going all in on any one sector or investment, a recipe for high volatility.”

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Tags: BNP Multi-Asset Trend Index, Commodities, currencies, DoubleLine Capital, Equities, Fixed-Income, Harry Markowitz, Jeffrey Sherman, Modern Portfolio Theory, momentum, quantitative analyst Eric Dhall, trend following

Princeton University’s endowment reported a 1.5% investment loss for the fiscal year ended June 30 as its portfolio’s asset value declined to $35.8 billion from $37.7 billion a year earlier.

Princeton University Investment Company, which manages the endowment, also reported that the average annual return on the endowment’s investments for the past 10 and 20 years is an impressive 12.2% and 11.0%, respectively.

“The challenging market environment in the past year reinforces the university’s long-term investment strategy: long-term investments that lead to long-term results that support long-term goals,” Princeton University Vice President for Finance and Treasurer Jim Matteo said in a statement.

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The endowment’s target asset allocation is 30% in private equity, 24% in independent return, 18% in real assets, 13% in developed markets, 9% in emerging markets, and 6% in fixed income investments and cash.

PRINCO defines the “independent return” category as consisting of investment vehicles that seek high absolute returns that are independent of broad market trends. It said that one distinguishing characteristic of managers in the category is that many attempt to exploit opportunities in over-valued assets via “short” positions that would benefit from price declines, as well as pursue more conventional “long” positions that benefit from price appreciation. Also included in the category are managers that focus on event-driven investments, such as those in companies going through mergers, acquisitions, or bankruptcy reorganizations.

With all Ivy League universities now reporting their fiscal year 2022 results, Yale University ended up on top as the lone endowment among the eight Ivies to report a positive gain for the year with a 0.8% investment return. The University of Pennsylvania came in second with a 0.0% return that translated into an $83.9 million investment loss. And Cornell rounded out the top three with a 1.3% investment loss for the fiscal year ended June 30.

The 1.5% loss reported by Princeton placed the university in the middle of the pack, with Harvard and Dartmouth ranking fifth and sixth with losses of 1.8% and 3.1%, respectively. Bringing up the rear are Brown University and Columbia University, which lost 4.6% and 7.6%, respectively.

According to a preliminary estimate by Cambridge Associates, the median result for endowments and foundations in the fiscal year ended June 30 was a 7.8% loss – the worst performance since 2009.