Drivers of asset selection

Asset selection consists of identifying markets, market sectors and individual assets that will do better or worse than the rest, and over- and underweighting them in portfolios. The higher an asset’s price is relative to its intrinsic value, the less well it should be expected to do (all other things being equal), and vice versa. The key prerequisite for superior performance in this regard is above-average insight into the asset’s intrinsic value, the likely future changes in that value, and the relationship between its intrinsic value and its current market price.


Mastering the Market Cycle by Howard Marks


The Hierarchy of Investor needs

Economic cycles

In this way, a cycle in the economic or investment world consists of a series of events that give rise to their successors.


But eventually something changes. Either a stumbling block materializes, or a prominent company reports a problem, or an exogenous factor intrudes. Prices can also fall under their own weight or based on a downturn in psychology with no obvious cause.


What the wise man does in the beginning, the fool does in the end.


First the innovator, then the imitator, then the idiot.


There’s only one form of intelligent investing and that’s figuring out what something’s worth and buying it for that price or less.


So the key to understanding where we stand in the cycle depends on two forms of assessment:

- The first is totally quantitative: gauging valuations. This is an appropriate starting point, for if valuations aren't out of line with history, the market cycle is unlikely to be highly extended in either direction

- And the second is essentially qualitative: awareness of what’s going on around us, and in particular of investor behavior. Importantly, it’s possible to be disciplined even in observing these largely non-quantitative phenomena.


For this reason, it’s important to note that exiting the market after a decline - and thus failing to participate in a cyclical rebound - is truly the cardinal sin in investing. Experiencing a mark-to-market loss in the downward phase of a cycle isn't fatal in and of itself, as long as you hold through the beneficial upward part as well. It’s converting that downward fluctuation into a permanent loss by selling out at the bottom that’s really terrible.

— Howard Marks


Mastering the Market Cycle by Howard Marks


Two investing objectives


The concept of liquidity is critical in investing but often misunderstood.

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market at a price reflecting its intrinsic value. In other words: the ease of converting it to cash.

In the Oaktree Capital memo, Howard Marks explains that investors often forget the latter aspect of liquidity - the ability to sell at a price close to intrinsic value.

In particular:

The liquidity of an asset often depends on which way you want to go … and which way everyone else wants to go.

He also lists several principles, which I've abridged here:

- In times of crisis, liquidity often goes to zero

- Usually the market wants to either sell or buy and liquidity exists in the opposite direction

- However, when everyone is confused and intimidated, the market freezes up and it can be hard to do both.

- No investment vehicle should promise greater liquidity than promised by its underlying assets

- Taking on large amounts of illiquidity is neither a winning or losing strategy per se


Liquidity by Howard Marks to Oaktree Capital clients

Understanding Liquidity, Investopedia

Liquidity, Investopedia

Invest for the long term

Investing over a long time horizon brings many benefits:

  • Lower volatility

  • Most absolute benefits of compound investing come in later years

  • Higher tax efficiency if invested in appropriate vehicles (UK ISA, US 401k, etc.)

  • Asset price driven by “value” not “perceived value”

  • Many opportunities overlooked

  • Lower transaction fees (because it requires less active management)

  • More asset classes available

It also comes with unique drawbacks:

  • Requires nerves of steel

  • Lower liquidity

  • Lower feedback loops

  • Require more data, reasoning to support decisions

To quote Sam Altman:

One of the few arbitrage opportunities left in the market is time. I think we have gotten really good at High-Frequency Trading, we have gotten really good at [measuring] the price of things. We have gotten worse at [measuring] the long-term value. I don't think you can go and beat the market in a lot of ways. But the one way I do is by making a long-term commitment to something. My new belief for how long I should hold stock in the best companies I invest in is forever. In a world that is increasingly focused on the tick and the quarterly revenue cycle, you should go the opposite way.


Sam Altman: How to Build the Future


15 uncorrelated bets

25 investing rules

1. Define what you’re incapable of and stay away from it.

2. You’re not proven until you’ve survived a calamity.

3. Plan on every plan not going according to plan.

4. Every product that changed the world was once belittled by the crowd.

5. The crowd is usually right.

6. Work for companies you would invest in and invest in companies you would work for.

7. Nothing’s free, so figure out the cost of investment returns – emotional, analytical, whatever – and be prepared to pay every cent of it.

8. Most great companies focus on the intersection of customer empathy and competitive paranoia.

9. Most great investors focus on the intersection of patience and contrarianism.

10. Most contrarianism is irrational cynicism.

11. Three types of businesses: Solve a customer’s problem, scratch a customer’s itch, exploit a customer’s vulnerability.

12. Solving a customer’s problem is the most lucrative and enduring, especially as access to information proliferates.

13. The biggest risks are things that aren’t in the news, as people aren’t preparing for them because they’re not in the news.

14. Reducing your desires has the same effect as leveraging your assets, but with no downside risk.

15. Spreadsheets cannot model trust and honesty, so due diligence always has to have a soft, subjective side.

16. Read fewer forecasts and more history.

17. Study more failures and fewer successes.

18. Reject existing beliefs as easily as you are persuaded by new ones.

19. No amount of intelligence can counteract the influence of extremely strong political beliefs.

20. Absorbing manageable damage is more realistic than avoiding risk.

21. Everything is ten times more complicated than it looks.

22. Solutions should usually be ten times simpler than they are.

23. The cure to overconfidence is constantly reminding yourself that you’ve experienced maybe 0.00001% of the world.

24. Highly overrated: Forecasts, goals, and multitasking.

25. Highly underrated: Options, systems, and getting along with people you disagree with.


Short Investing Rules by Collaborative Fund, Morgan Housel


The hierarchy of investor needs

On-boarding deals

The strategy of using acquisition offers from businesses to reduce or optimize spending.

Start-ups and larger companies often resort to offering discounts to facilitate customer acquisition. By following a non-traditional usage pattern of switching from one company to another during an offer, a user can exploit these acquisition offers for significant financial benefit.


How to Live in San Francisco Without Spending Any Money

Money Savings Expert (UK)

Risk parity

Risk parity is an improvement over traditional diversification methods. It allocates assets so that different asset types have equal overall risk exposure influenced both by allocation weight and volatility.

Illustratively, imagine you have to allocate $1,000 across stocks & bonds. We're also given that stocks are 2x more volatile than the bonds. Traditional diversification would advocate buying $500 worth of stocks and $500 worth of bonds - a 50-50% split. However, according to risk parity, we should buy $667 worth of bonds and only $333 worth of stocks. Risk parity research merits that this new allocation will have the optimal risk-return characteristics of any allocation.

Q: Do returns of the individual asset classes matter in this model?

A: Risk is more important than returns in this model, but it's important that volatile assets have higher returns and less volatile assets have smaller returns.

Q: Wouldn't this portfolio have a lower overall return?

A: Yes, a portfolio can have a better risk-adjusted return but lower overall return. To increase the absolute return of a risk parity portfolio, all asset classes are leveraged.

Q: Are there any implicit assumptions in risk parity?

A: A recent paper by JPMorgan called Improving on Risk Parity suggests that risk parity implicitly assumes equal Sharpe ratios (risk-adjusted returns) across asset classes. They also think these will change going forward and in that case risk parity would under-weigh better performing assets.

Risk parity can also be applied recursively within an asset class.


Bridgewater All Weather Strategy

Wealthfront Risk Parity

AQR Whitepaper on Risk Parity


15 uncorrelated bets



15 uncorrelated bets

15-20 uncorrelated investments (at any risk level) offer significantly better risk/return characteristics than a single investment. Also called the "Holy Grail of Investing".

I asked Brian Gold, a recently graduated math major from Dartmouth who’d joined Bridgewater in 1990, to do a chart showing how the volatility of a portfolio would decline and its quality (measured by the amount of return relative to risk) would improve if I incrementally added investments with different correlations.


I saw that with fifteen to twenty good, uncorrelated return streams, I could dramatically reduce my risks without reducing my expected returns.
— Ray Dalio


Principles by Ray Dalio (page 56-57)

For a model portfolio of a Risk Parity strategy, refer to Reverse Engineering AQRs Risk Parity strategy


Risk parity

☝️ Watch this rare video (starting at 6:00) where Ray Dalio explains why he invests in at least 15 uncorrelated bets at each time.