What Sets Us Apart
Minding the Right Errors
False-Positive / False-Negative vs. Tracking Error
Errors are the gateway to failure and preventing or minimizing errors is a key ingredient of investment success.
Conventional strategies are mainly preoccupied with the so-called “tracking error”—the degree to which their performance diverges from that of its assigned benchmark which, in turn, is most frequently specified by a strategic allocation model (e.g., 60/40 stocks/bonds). To keep tracking error low, conventional offerings intervene frequently to rebalance their portfolios, even when the tracking error has resulted in increased returns and/or lower risk!
Cognizant that the payouts of asset classes vary widely and unpredictably over time, our strategies consider allocation-derived tracking errors to be only secondary signals of portfolio health the meaning of which needs to be properly contextualized within the broader navigation of market regimes.
In contrast, our strategies pay very close attention to and work tirelessly to minimize two critical errors whose significance has only emerged in the recent stages of the evolution of investment thought and practice—false-positive and false-negative errors.
 |
False-positive errors (crying wolf) are committed when portfolios heed transient or head-fake signals and unnecessarily reposition defensively within an otherwise still-constructive market environment.
They abound within bull market regimes and are the source of multiple disadvantages—costly whipsaws, punitive tax liabilities, performance drag, expensive trading friction costs, and, ultimately, incremental shortfall risk (cf. the CoViD market crash of 2020, with its 17-day below-twenty-percent flash ‘bear market’ and its V-shaped ultra-short economic contraction).
 |
False-negative errors (blinders) are committed when portfolios disregard veritable signals of a bearish market-regime shift. They leave portfolios open to the full brunt of a protracted generalized market downturn (cf. Global Financial Crisis of 2008/2009 and the dot.com bust of 2000 – 2002).
 |
OUR STRATEGIES pay close attention to and work tirelessly to minimize both false-positive and false-negative errors by leveraging their expertise in assessing the status of the market regime and tracking veritable signs of a market-regime shift. In this way they aim to maximize the capture of sustained upsides while reducing the capture of sustained downturns without the interference that accompanies tracking error considerations.
Owning to their allocation constraints, Conservative/ Income-oriented and Moderate/Growth-&-Income-oriented portfolios are prone to committing a false-positive error with virtually every rebalancing downshift they do during bullish market regimes (by selling “overweight” equities to buy fixed income). They are also prone to committing a false-negative error with virtually every rebalancing upshift they do during bearish market regimes (by programmatically reducing ‘overweight” fixed income to buy equities). Aggressive/Growth-oriented portfolios are similarly prone to false-negative errors at every rebalancing upshift they do during bearish regimes, although they appear to be less prone to false-positive errors during bullish market regimes.
The overall shortcomings of conventional portfolios in the management of false-positive and negative-errors do not merely affect ongoing performance—by lowering returns and increasing measures of volatility and drawdown—but they also adversely impact investors’ ultimate risk by increasing the probability of shortfall.