An Introduction to Fortuna Investors’ Asset Management Framework

This article will address a key question that we get regularly from prospective clients:

What makes Fortuna’s asset management framework different from most money managers?

There are five main areas to cover:

We are quantitative investment managers.

We diversify broadly and meaningfully.

We use trend and momentum for downside risk protection and upside outperformance.

We use individual stocks and low-cost ETFs to reduce costs for our clients.

We invest side-by-side with all of our clients – we have a lot of skin in the game.

Lets take these topics one-by-one:

We are Quantitative Investment Managers

Everything we do is codified. We follow rules, not opinions, not our intuition, the Wall Street Journal or the talking heads on CNBC. When we allocate and rebalance our portfolios, positions are selected by a process that requires no human decision making, only adherence to a process.

We diversify broadly and meaningfully

We look to the entire world as our opportunity set, not just what is available here in the US, and not just stocks and bonds. We will take meaningful position sizes (20%+) in assets like gold, oil, real estate funds, or European or Asian equities when the conditions dictate.

We use Trend and Momentum rules to seek downside risk protection, and upside outperformance

Trend

We use trend to help us with two things:

1)      Reduce risk

2)      Avoid “dead money” assets

Most people get the risk-mitigation idea easily enough, but many forget about the dead-money issue.

Dead-money assets are those that chop sideways for extended periods of time, inflicting opportunity costs on an investor who could otherwise allocate those funds elsewhere.

Most people don’t think of stocks as potential dead money assets, but they can be, and here is proof.

The below chart shows the performance of US stocks (Dow Jones Industrial Average) back to the early 1900s.

The fact is US stocks went nowhere for 15 years during the 1930s and 1940s, for 6 years in the 1970s, for 6 years in the early 2000s and another 4.5 years in the latter half of that decade.

Since 1973, US stocks have grown at a rate of 10.3% annualized. The graph below shows the growth of $10,000 invested in the S&P 500 over that half-century.

What DOESN’T stand out here, is that there were awful periods on that road to 10.3%...

Here is a drawdown chart for the same portfolio. This shows the tough times for an investment strategy. Notice that the Y axis starts at 0 and most of the values on the chart are negative.

The easiest way to think about this chart: anytime the account is at an all-time high, the drawdown is at 0. Whenever the account is not at an all-time high, the account is in drawdown.

Notice the 6.5 year drawdown in the 1970s, and what was essentially a “lost decade” in the 2000s.

Those who buy and hold can waste precious time sitting on dead money for years on end.

Beyond the long duration of these drawdowns, they can be deep: -45% at the 1974 low, -30% at the 1987 low, -45% in 2002, and -51% in 2009.

This point is especially salient for those who are nearing or in retirement, or who are considering a lifestyle change (home purchase, starting a business, retiring a spouse to stay home with the kids, etc.).

As we navigate these critical life transitions, reducing downside is of utmost importance.

Downside risk and dead-money are what we are trying to avoid, and trend rules can sometimes help us do this.

A trend rule is simply a tool that helps you determine if an asset is in an uptrend, downtrend, or neither, and then stipulates how you will invest depending on that signal.

One of the ways we mitigate risk in our portfolios is to avoid assets that are not in defined uptrends.

Let’s look at an example:

Consider the following rule: Only own US stocks if the US stock market is in an uptrend, hold cash instead (if US stocks are in a sideways or downtrend). We will use the 200-day moving average of prices as our trend signal for this simple example.

What is a 200-day moving average? Simply average the closing prices of the index over the past 200 days and that is today’s value. Tomorrow, take the same measure – the last day in your data set (201 days ago) will fall off as the moving average lookback window shifts forward a day.

The moving average is simply a trend smoother. In the below chart it is the orange line, whereas the red and green bars reflect daily prices.

You can see how the trend line “smooths out” price action and helps us see when the asset is in an uptrend or a downtrend. You may also notice that the average “lags” prices – there is nothing “predictive” going on here!

Back to our rule: Only invest in US stocks (S&P 500) if they are trending higher, otherwise, own cash, using the 200-day moving average as our trend barometer.

Below is a summary of how our new rule performed relative to simply buying and holding the S&P 500.

We see that with this simple rule, we have cut our downside risk by more than half!

We do see however, a meaningful reduction in the growth rate as well, of about 0.9% per year.

We will talk about ways to drive upside later in the paper, but for now we are focused on the risk reduction and enhancing risk-adjusted returns.

Speaking of risk-adjusted returns, what are they? Risk-adjusted returns help to put the return of a strategy in context of how much downside volatility or pain was required to achieve that return.

Generally, a portfolio with higher risk-adjusted returns is a better one, assuming total returns are similar.

We show the Sortino Ratio above, which is a measure of risk-adjusted returns. A portfolio with a higher Sortino Ratio, all things equal, has exposed its holder to a lower level of risk per unit of return achieved. We like high Sortino Ratios, and we note the increased Sortino Ratio above from using the trend rule.

This is all well and good, but is there something special about the 200-day moving average? If this process works, it should work with other moving average periods as well, otherwise we might be cherry-picking.

Let’s run the same test as above, but use different lookback periods for our moving average, from 120 days to 280 days.

There are slight variations to the results depending on your trend lookback, but as you can see, the rule is what we call robust. It is not fragile - it doesn’t rely on a single parameter, but rather works broadly. Markets do trend, and this is a simple rule that we can use to exploit that anomaly and reduce downside risk.

It's clear that using trend can help to protect against downside, but what about the dead-money issue?

Remember, we want to avoid leaving capital invested in assets that are going sideways or down for long periods of time. When we use a trend rule, we can take the capital that would otherwise be allocated to a dead-money asset and invest it elsewhere where trends are favorable.

That brings up another important question – how do trend rules work on other asset classes? If trend rules are indeed robust, they should work for other asset classes as well.

Let's look at some other asset classes for insight. Again, we will just use the 200-day moving average rule for illustrative purposes.

Pretty good. Generally, using a trend filter as a rule has resulted in similar or enhanced returns relative to buying and holding the same asset, but with a substantially lower level of risk.

Also, consider that when our trend rule tells us to be “out” of an asset, we can deploy those dollars elsewhere and seek returns, we don’t have to let that capital sit in cash.

Before we move on, let's discuss one last idea related to trend. Most investment advisors don't suggest buying and holding only one index. Instead, they recommend buying and holding a variety of diversified funds.

Many advisors advocate for a passive allocation to multiple, diversified index funds to create a portfolio, which is decent advice.

Let’s take a look at how, using trend rules, we can improve upon that advice.

For the buy-and-hold portfolio, we will hold the following assets in equal weight (11.11% each), rebalanced semi-annually.

●        Long term US treasury notes (20-30 year)

●        Intermediate term US treasury notes (7-10 year)

●        US large cap stocks

●        US small cap stocks

●        Foreign stocks

●        Foreign bonds

●        Commodities index

●        Gold

●        US Real Estate Investment Trusts (REITs)

For the trend portfolio, we will hold the same assets at the same weights, but only if they are above their long-term moving averages, and cash otherwise. We will check the trends once per month and rebalance the portfolio accordingly.

For instance, say long term treasury notes, short term treasury notes, gold and commodities are displaying a down/sideways trend, and the rest of our assets are displaying a positive trend. In that case, we would hold 4 units of cash (~44.44% of the portfolio), and an 11.11% allocation to each of US large cap stocks, US small cap stocks, foreign stocks, foreign bonds and REITs.

Here is how this ruleset has performed:

Using the trend-following strategy for a portfolio of assets resulted in slightly lower returns compared to a buy-and-hold portfolio. However, this marginal reduction in return came with a significantly lower level of risk.

Higher risk-adjusted returns mean better portfolio efficiency. If higher absolute returns are your goal, you should seek out the highest risk-adjusted return available, and then size the portfolio as appropriately (using leverage, if necessary) to align with your risk tolerance. Another thing you can do to enhance returns is to integrate momentum rules in addition to your trend following rules. Speaking of which…

Momentum

When many assets are trending higher, we have two choices – we can either own all assets that are trending higher, or we can select only the highest-performing assets and concentrate our portfolio into those. The latter strategy is called momentum investing.

Momentum helps us measure relative strength across assets. If I have stock A, which is up 50% over the past 2 weeks and stock B, which is up 10% over the same time period, then stock A has stronger momentum than stock B.

There are myriad studies which show that price momentum tends to continue in financial markets. Put another way, the things that have recently gone up the most have the best chance of continuing higher.

To demonstrate this, let's look at the same 9 asset portfolio as above. Again, we will show the buy-and-hold portfolio and the trend rule, and then we will add the momentum rule.

The momentum rule is as follows: Each month, rank the 9 assets by price momentum over the past 200 days. Only own the top 3 assets as ranked by momentum.

This rule combines with our trend rule from before. Put simply, we are only going to own an asset if a) it is in an uptrend and b) it has high relative momentum.

If fewer than 3 assets meet our trend criteria, then we will hold a portion of the portfolio in cash. Note that we could theoretically hold a 100% cash portfolio if all asset classes are trending down / sideways.

Lets see some test results:

The trend rule helps to reduce downside, and the momentum rule helps to enhance returns. Together they make a powerful cocktail.

Trend, momentum, asset class diversification, and signal diversification are the foundations upon which our investment framework is built.

We bring everything together under what we call our Global Enhanced Alpha suite of strategies or GEA.

GEA consists of three separate strategies, each with their own internal parameter diversification. Those three strategies are called The Fortuna Alternative Strategy, The Fortuna Stock Strategy, and The Fortuna Defensive strategy.

Each client’s goals, risk tolerance and objectives determine their allocations to these three sub strategies. Our 4 main models are called GEA Standard, GEA Balanced, GEA Conservative and GEA Levered. We also run an aggressive strategy for risk tolerant investors with Qualified Accounts, where leverage is unavailable, called GEA IRA Aggressive (not pictured below).

We use individual stocks and low-cost ETFs to gain exposure to markets, reducing costs for our clients.

We use low-cost ETFs to access asset classes such as gold, commodities, and stock and bond indices. We also trade individual stocks, which do not have an expense ratio. The simple average cost of the individual ETFs that we might own is 0.27% (see the table below), but the weighted underlying expense load for our strategies is usually substantially lower over the course of any given year.

Fortuna’s investment management fee is 1%, so with underlying expenses, that puts you at 1.27% all in, at the high end.

You have several options when it comes to paying for investment management. It would be impossible to lay them all out, but here are the most common:

1) Do it yourself (DIY). If you have the time, energy, capacity and knowledge, then this is a valid option. We believe that DIYers can succeed at this game if they put in the time and effort. At face value, monetary costs are small today, but consider the opportunity cost of missed years of efficient investing if it takes you some time to learn. Not to mention that once you have a strategy, you need the time to run the numbers, place the trades, reconcile your models with live performance, and you can’t skip a rebalance because you’re traveling, busy with work, etc.

2) Open up a robo-advisor and get pure passive buy-and-hold exposure without anything extra. Smaller potential for global diversification, smaller allocations to alternative assets, no trend or momentum rules, no active downside risk protection or any attempt at outperformance. This will cost you about 0.25% annually. It's not the worst option.

3) Choose a “passive” advisor. These advisors will put you in a passive portfolio that is at best like that which you would get with a robo-advisor and at worst much less efficient, and they will charge you more. Total fees generally range from 1-2%. Again, you don’t get any of the benefits of trend following, momentum, etc. If your advisor is good, they will add value to your financial situation in other ways such as tax and estate planning, and general organization of and guidance in your financial life.

4) Choose an advisor who uses third party managers. These advisors will invest your money in funds managed by third parties (mutual funds, turnkey asset management programs, platforms). Sometimes those third parties themselves have third parties behind them. Consider that every intermediary between you and your money is a layer of fees. True costs can pile up substantially here, and say goodbye to transparency or the ability to communicate with the person who is actually making investment decisions.

5) Choose Fortuna. We will manage your portfolio according to your goals and objectives using the tools and methods outlined above. Since the inception of our strategies in 2018, our methodologies have produced results in excess of industry benchmarks even after accounting for the costs of our services, with less risk than passive benchmarks. Our long-term data set indicates that we have the potential to substantially outperform and reduce risk in the future. Get access to everything we spoke about above, and an investment methodology that is built to weather all markets, not just bull markets.

We invest side-by-side with all of our clients – we have significant skin in the game.

We didn’t start our business with the question, “how do we raise assets?” We started by asking, “how do we achieve higher risk-adjusted returns?”

We started as independent traders and investors obsessed with asset and risk management.

It was only once we realized that we had something worth sharing, that we began managing money.

We invest side-by-side with our clients, and we apply leverage to our personal positions. We are more than completely aligned with our investors.

Fortuna Investors is a registered investment adviser. Information presented herein is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investment advice can be provided only after the delivery of Fortuna’s brochure and brochure supplements (Form ADV Part 2A&B) and once a properly executed investment advisory agreement has been entered into by the client. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser, tax professional, and/or legal counsel before implementing any investment strategies discussed or purchasing any securities. Any model performance shown for the relevant time periods is based upon hypothetical results of that model. Model portfolio performance is the result of the application of a Fortuna Investors investment process. It does not reflect any investor’s actual experience with owning, trading or managing an actual investment account. Backtested performance is not an indicator of future actual results. There are limitations inherent in hypothetical results, particularly that the performance results do not represent the results of actual trading using client assets, but were achieved by means of retroactive application of a backtested model that was designed with the benefit of history. The indices used by Fortuna Investors, such as the S&P 500, have not been selected to represent an appropriate benchmark for any investor, but rather are disclosed to allow for comparison of performance to that of certain well-known and widely recognized indices. Indices are typically not available for direct investment, are unmanaged and do not incur fees or expenses. PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS