GestaltU on Efficient Allocation

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  • on June 15th, 2013

Sometimes a great piece of insight can just be shared, but sometimes it needs to be shouted. This is more of an allocation piece than a trading piece, but since we’re all looking to make the most efficient allocation of both our financial and psychological capital I think the latest from GestaltU is relevant for all of us.

Building on the work of Mebane Faber’s groundbreaking 2006 paper A Quantitative Approach to Tactical Asset Allocation, they’ve released a series of articles discussing dynamic asset allocation. They continue to crush it, raising the bar again on the application of momentum to an investing strategy.

Before reading the paper, let me highlight the key points for those who don’t feel a need to comb through the math. The methodology behind their work is loaded with gems of logic that I break down as follows:

1) Momentum works

2) Multiple measurement methods helps confirm/refute findings

3) Multiple timeframes ensure a lack of reliance on an “optimal” lookback period

OK, now go read the paper; if you want to come back for my favorite concepts I’ll be waiting here.

Awesome, right? These guys capture the essence of all things great about technical analysis and reduce notions of data mining to shreds. How about this barrage of wisdom:

“this helps to control for the chance that strong performance is simply the result of one dominant asset class over the period.”

“avoid the distraction of searching for a priori local parameter optima which will almost certainly NOT prove to be true optima out of sample.”

” a rare test of robustness across methodologies”

I have to admit to confirmation bias regarding their approach, as I’ve built my entire breadth process around “the ability of different measures to stabilize the estimate using simple or advanced ensemble process”.  But my favorite of all is the following:

“Unlike trend following approaches, which measure the state of a trend, our momentum indicators measure the strength of a trend. Crossover systems are either long or short, which means they are binary variables, whereas the momentum indicators provide discrete variables that allow us to compare the relative strength of the trends.”

This is where it comes back to efficient use of our time, capital, and emotions. We can’t just keep buying every uptrend we see. OK, I suppose we can, but only if our sizing model puts us in tiny positions that leave room for a zillion more. If we believe in trends and momentum, don’t we want to own the most dynamic of trends? And don’t we want our largest capital placed in those with the most potential? Doesn’t this require us to, at times, replace a solid but waning trend with an emerging one?

The obvious parallel here is a pro sports GM with finite resources; who doesn’t love competitors like Albert Pujols and Brian Urlacher and Paul Pierce(?) but sometimes hard choices have to be made. This is where my efforts lie, somewhere between pure trading and pure trend following. I know myself well enough to know that I can only handle a few positions at a time, and that I don’t like to hold during corrective periods.

To an investor, the Nikkei may be in an uptrend, but to a trader the last month has been a roaring bear. I want no part of either side; it was smooth sailing for a few months and now it’s not. If it gets smooth again I’m wide open to participating, but my needs are far more zen than warrior so I don’t go out in search of the “battles” of trading lore.

Back to GestaltU and their contribution. I have an amazing TradeStation programmer whose views on trading and system design I trust completely; I excitedly sent him the paper and he said “yeah, I’ve read that a few times and started sketching out some ideas.” Of course he has, it’s a perfect complement to his profile-based $ES_F trading. For those of us lacking the desire to read academic papers or “out-math” anybody, the team at GestaltU provides enormous value by delivering:

1) Identification of a problem/need

2) Pursuit of a solution steeped in logic and evidence

3) The ability to clearly communicate both 1 and 2

To me, these are equally valuable skills that open the door for non-geeks to learn and contribute. Just as Meb’s paper tore across the industry and changed the way many advisors allocate funds, I believe the guys at GestaltU are in the process of doing the same and provoking thought in the minds of investment pros.

Or maybe I’m just a momentum addict. In any case, do yourself a favor and read everything they’ve written in the past year. I don’t know these guys from Adam, but I really appreciate their generosity in sharing both their philosophy and process with the rest of us at no charge. Tomorrow’s hot stock, no. Well-researched ideas to drive position sizing and money management and risk control, for sure. The Blogosphere wins again.


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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