Behind the Scenes of a Quant-Driven Family Office

Test Drive Our Easy-To-Use Algorithmic Portfolio Construction Tool

In my last post, I discussed the fact that we were named chief investment officer of Redwood Family Office, a division of Redwood Private Wealth. Today, I’ll begin documenting what it looks like to run a family office from the inside…

The first order of business has been to install the philosophy of merit and quantitative standards utilized by the likes of Renaissance Technologies while unwinding the counter-productive heuristics that govern retail financial advice—not the least of which is the belief that the S&P 500 represents the standard for investment performance.

So let’s start by taking a look at the S&P 500—particularly its liquidity characteristics—as a means to begin making responsible, merit-based investment decisions…

As measured since January 2007, the expected return of the S&P 500 is 9.36%, and its probability of loss weighted by its expected degree of loss (its risk) annualized is 19.94%. We talk about these measures extensively elsewhere, and we’ll continue to, but the issue for today is its liquidity characteristics.

Most financial advisors will tell you that you can’t time the market and that indexing (i.e., buying a fund that is comprised of stocks that mirror the S&P 500) is the best way to invest, but timing is everything with indexing…

If you happened to have invested in the S&P 500 around October 2007 expecting just under a 10% annual rate of return, you’d be sorely disappointed. It’s generated right at 4% annually since then.

So, how do you use this insight?

When people invest, they do so planning to realize a given expected return, and we operationally define liquidity based on this expectation: under the worst case scenario, how long will it take to realize the expected return.

That’s how long you should be prepared to hold an investment.

In other words, the maximum drawdown duration required to realize an investment’s expected return as measured since January 2007, or earlier, should be less than the investment time horizon of the mandate. That—as closely as possible—guarantees the investment expectation will be realized.

Despite the traditional definition of a liquidity, it doesn’t matter if an asset can be traded intraday. I can take a hundred dollar bill and exchange it at any time for a twenty with someone else. That’s not a helpful transaction no matter how quickly or how often I can execute it.

As I mentioned in our last post, Daniel Berger joined Daltok Capital Managment as a managing partner and provides invaluable education to investors and investment professionals as a contributor to Adagio Institute. Here’s an excerpt of his discussion on investment quality, liquidity, and maximum drawdown duration:

We’ve talked about risk and return measures extensively in previous posts, and we’ll revisit them in later posts.

To put all of this into practice now, we’ve developed an algorithmic portfolio construction tool for Redwood Family Office.

It constructs a portfolio of the best performance possible for any given investment time horizon, income and cash reserve requirements by strategically assembling the best asset managers in the world that we’ve been able to identify by our rigorous quantitative standards.

I decided to provide you, our high-net-worth and institutional investor following, a glimpse behind the curtain into our family office—an opportunity for you to construct your own portfolio to see how your money would perform if it were optimally employed by our quantitative standards…

You probably won’t believe what you see until you remember that we’re applying Renaissance-level sophistication and rigor. Simply input a few very basic parameters, and see for yourself: