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Fortuna’s guiding principles

A quantitative discipline rooted in rigorous testing and data

Every decision in our investment process is generated by a set of rules. These are not mere guidelines, but exact instructions for when to take positions, the size of those positions, and when to sell. Trading by rules alone, without any influence from our personalities and moods, eliminates noise and confusion from the investment process and ensures that each decision is the statistically optimal one.

Our process systematically harnesses the factors that drive returns, and incorporates multiple layers of downside protection. We have taken great care to avoid over-optimizing our rules to past data, and have designed our systems to be robust to an unknown future.

True diversification

True diversification means different asset classes, not different securities. Diversification is only meaningful if the assets in question are not highly correlated. For instance, a stock portfolio of several different industries is of little help in a bear market, when virtually all stocks decline. We may gain a measure of safety by owning different world markets, but even then we will be subject to global downturns.

It is only when we add uncorrelated asset classes that our portfolio starts to become truly robust, as when stocks fall, commodities or bonds may rally. Diversification also helps with upside, as a given market or sub-strategy may languish for years, but a global investment universe allows us to rotate into the best performing assets wherever they may be found.

Strict risk controls

Diversification is a rock-solid foundation for controlling the downside of a portfolio, but we go a step further by limiting the position size of each investment we make, and by avoiding markets that are in defined downtrends. One of the largest pitfalls in investing is a reluctance to close a losing position, a form of denial known as riding the “slope of hope.” A strict sell discipline ensures that declining positions are closed before losses are extended. When a sell discipline is applied across a diverse, uncorrelated investment universe, the downside of the portfolio as a whole is dramatically reduced.

Historical perspective

We are students of the broad sweep of market history, not just recent years. History teaches that market environments are constantly changing in unpredictable, often counterintuitive ways. A truly robust portfolio must be able to withstand crashes as well as periods of inflation, deflation, and stagflation. It should have weathered the 1970s and early 1980s, when stocks languished and bond yields shot to the mid-teens. It should also have spared investors the anguish of two 50% declines in the 2000s. To design a portfolio that is simply robust is easy, but to build one that may not just survive, but thrive and outperform through such chaos takes both a respect for the unknown and a drive to seek returns that others ignore.

Structural inefficiencies and misplaced incentives create opportunity

Market prices reflect the prevailing narratives and emotions of the world’s investors. Their collective beliefs, hopes, and fears do not change in linear, predictable patterns, but in chaotic, dynamic feedback loops, manifesting in bubbles and crashes. When the most powerful computers still can’t predict the weather with any precision beyond five days, how can we divine what lies ahead for market prices? Humility requires that we take a measured approach to the future, one refined in probability theory. What matters is not precision, but that we can exploit consistent, statistically significant market anomalies. Such known and exploitable patterns are well-defined in the academic literature, but misaligned incentives and widely held prejudices prevent most investors from taking advantage of these opportunities.

Robusticity and respect for the unknown

We use statistics to handicap outcomes, place measured bets, and know when to fold. That said, we have a healthy respect for the unknown unknowns that can’t be quantified in any model, so we design our systems to be robust to events that have never even happened. Our systems are not simply built to suit what has already happened, but are universal frameworks designed to perform well into the future.

Risk is perhaps the most tragically misunderstood concept in finance. Traditionally, perhaps out of convenience, volatility as measured by standard deviation has been a proxy for risk. However, a close examination of market history reveals the recklessness of this assumption, as illustrated by Nassim Taleb in his works such as The Black Swan and Fooled by Randomness. An investment strategy may deliver steady returns with very low volatility month after month, perhaps for years, and then blow up spectacularly in a few days. A classic tale is that of Long Term Capital Management, a hedge fund run by two Nobel laureates, the meltdown of which single-handedly created a financial crisis in the summer of 1998.

In the case of LTCM and countless others, the managers failed to ask, what if?  What if our assumptions are wrong? What if the future is not like the past? What if there is some other factor that we have not considered? What can break us? It doesn’t matter if it has never happened. Can you conceive of a 50% crash in global equities within a single month? It hasn’t ever happened, but why couldn’t it? Could your portfolio survive? What if bonds and gold were to fall at the same time as stocks? What if the US stock market enters a 30-year secular bear market like Japan?

When investing for a lifetime, survival comes first, followed by consistency.

No extra theoretical gain is worth the risk of a devastating loss or year upon year of inadequate returns. We believe that our program offers investors the very best chance to meet their goals, no matter what the future has in store.

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