Novatero State of the Funds Report for Q4 2020

I dislike reporting on returns. Yes, this is absolutely ridiculous, since returns are what this industry boils down to at the end of the day. A grandiose investment thesis that perfectly follows a rigorous designation of portfolio constituents doesn’t mean a damn thing if it produces a return profile below the benchmark. I can be as clever as I want with GAIA and NRCH, but if they are not producing growth for the capital invested in them, then they’re not going see anyone interested in allocating hard-earned cash toward them.

I dislike reporting on returns…because returns can be highly misleading. “Past results are not indicative of future success” and variations on this phrase are a requirement for investment vehicles, justifiably so. However, returns are usually presented in isolation from the forces that drive performance. If a strategy crushes the benchmark for four straight quarters, is it due to the strategy itself, or did it get lucky and fire off four quarters of performance at the upper end of its range of potential outcomes? Actual returns are what we typically see, but without an understanding of the expected return, we’re bereft an anchoring point of data that allows us to have a better understanding of whether or not a strategy is truly performing well or just had a run of good luck.

What do I mean when I compare Actual to Expected? Think in terms of the gap between research and execution. The expected returns for GAIA over the in-sample, out-of-sample, and track record periods present a world in which Novatero is able to get the exact position amounts at the posted opening or closing price of a position 100% every time. That…doesn’t really occur in the real world. Prices move faster than humans, and some positions may be difficult to get into or out of. Running the algorithms and models for GAIA is done with recent data, which may not be as iron-clad as the historic data used to originally build the strategy. Known unknowns and unknown unknowns will rear their heads over the course of enacting a strategy. Despite these hurdles, does your strategy stick close to what the research side would expect? Is your alpha fading over time? Comparing Actual to Expected isn’t a perfect solution, but it does provide a better picture of how close the management of the strategy gets to the academic expectation.

So, with all that being said…let’s see how we’ve done over the past half-year.

GLOBAL ANOMALOUS INDEX ALLOCATION (GAIA)

Expected - 26.00% (13.22% Q3, 11.29% Q4)
Actual - 20.79% (10.87% Q3, 8.94% Q4)
Benchmark (VEU) - 22.58% (5.96% Q3, 15.68% Q4)
S&P 500 - 21.15% (8.47% Q3, 11.69% Q4)

Since starting GAIA’s track record back in July, it has returned over 20% due to strong showings in the back half of 2020. However, its performance lags behind the expected return of 26%, as well as coming in lower than both the S&P 500 and GAIA’s benchmark, the Vanguard FTSE All World ex-US ETF (VEU). I’ll shoulder the blame for this: GAIA is the first track record we’ve run, and there have been some growing pains along the way over the past few months in terms of position sizes, portfolio weighting, and getting into some of the smaller countries (we’re looking at you, Mongolia and Kazakhstan). Data collection is also only carried out once a week at the moment, leading to some shaving off of alpha due to holding older positions slightly longer than expected. Still, despite all of these bumps GAIA is performing in-parallel to its expectation from the research side, if a bit lower than we’d like. As we continue to iron out the wrinkles in the track record we should see the actual move closer to the expected.

NEAR-TERM RESPONSE TO CORPORATE HEURISTICS (NRCH)

Expected - 86.80% (15.05% Q3, 62.37% Q4)
Actual* - 74.26% (6.24% Q3, 64.03% Q4)
Benchmark (Russell 3000) - 20.39% (0.72% Q3, 19.52% Q4)
S&P 500 - 21.15% (8.47% Q3, 11.69% Q4)

First off, that lovely asterisk above is because NRCH is currently paper trading. This can be thought of as a sort-of interregnum between the research portion and a track record: you hold virtual positions with virtual money. This eliminates some of the deviations between Actual and Expected (finding a counterparty to buy/sell, illiquidity, etc.) but it does allow for truer-to-life weightings, movement, and more.

Secondly, yes, those Q4 returns aren’t a typo. NRCH has a knack for finding the occasional diamond in the rough that then goes on to deliver a massive return over the quarter(s) that it is in the portfolio. NRCH benefited from the huge jump that Oasis Petroleum (OAS) took in mid-November, as well as strong returns from a majority of the companies in the portfolio in Q4. In fact, the actual return for NRCH outperformed the expected return because of a favorable tilt to some small deviations in weighting. Ideally we’ll be using fractional shares going forward to eliminate some of the weighting issues.

Finally, let’s talk about the discrepancy between Actual and Expected in Q3. It’s a fairly sizable gap and could be portent of future deviations between the two returns. However, most of this falls on a tweaking of the EASE and NRCH models mid-way through Q3. With the tweak, some positions were no longer correct and were adjusted toward the back half of August. The return difference between Actual and Expected from September onward hew close to one-another and show promise going forward, but we’ll continue to monitor this separation in the paper trading or soon-to-be track record for NRCH.

The fast-paced nature of venture capital has led to a massive acceleration in the movement of startups looking for funding and the chance to strike it rich. I’ve always been…reticent to move at a speed that feels inconsistent to the underlying business itself. Fortunately, GAIA and NRCH, no matter how clever the strategy nor how large the returns, can only move at the speed of the market. This can be frustrating at times, as it takes the growth of Novatero and making GAIA, NRCH, and our other work-in-progress ideas into funds that you can invest in, out of our hands. As much as we’d like to get these funds out there and really start helping investors, we also know that these sorts of things cannot be rushed, especially from out position outside the typically confines of the investment industry. Until that moment, we’ll be here updating you on our strategies and providing our perspective on a variety of topics.