Why active risk management may offer more resilient portfolios

JOHN KAVOLIUS: We've had a recessionary period and expansion, and then a peak in quick succession. And then in 2025, the opinion on what's going to happen in the market, whether it's more growth or growth scare, varies on the day. What makes your approach so versatile and gives it the potential to outperform during these unique market environments?

AZIZ HAMZAOGULLARI: But then the question is, as you said, why is that? And the reason is the way we construct our portfolios takes into account, not a risk on/risk off reactionary approach to risk, but rather a very proactive approach to risk, which is if you look at not just 2008 to 2010, or 2022 to 2024, but lost 150 years, a much bigger approach to analysis of history, what you find is in 150 years, we had 23 times when the markets corrected 15% or more, or call them like tail events. 

And actually, in the time that I have been an investor in the last three decades-plus, the frequency increased. Instead of every 6 and 1/2 years, we are having every 4 and 1/2 years a drawdown that's big in magnitude. And if you go back and look at these events and read the papers back then, 100 years ago, 150 years ago, or recently 20 years ago, 10 years ago, what you're going to find is right the day before, the month before, the year before these events, almost nobody was talking about them being a risk. 

After they became clear that they were risks, so for example, when we had the global financial crisis or when we had the pandemic, but if you go back in the history, when you had the Bretton Woods collapse in 1972 to '74, when the market was down 42%, or when the Internet Bubble burst in 2000, that was like down 44%. When you look at these, there may be one or two people talking about it, but even those calling for these corrections, look at their track records. It's not that great because they may have called the macro, but they couldn't get the portfolio right. 

So we believe that first you have to embrace this volatility. You have to accept the fact that volatility is part of investing. And it's almost impossible to predict these events, unless somehow you're being informed a day before that there will be a big correction and consistently doing that is impossible. What we do instead is taking an approach of risk is always on, and you want to diversify your portfolio with different business drivers. 

So meaning looking into the future and asking a very simple question. There are all these enterprises and consumers, what are they going to be purchasing and why? And you basically combine businesses that are not related to each other. So for example, if you look at our portfolio, we have a company like Monster Beverage, which is driven by growth in per-capital consumption in energy drinks. The correlation of that growth to a company like Regeneron, which is a health company, or Vertex, which is another health company, is close to nothing because the patient population in cystic fibrosis for Vertex or patient population for eye disease for Regeneron has almost no bearing on what happens in energy drinks. 

And if you look at those growth drivers with e-commerce like Amazon, there's not much correlation. So if you build a portfolio of businesses that you think are going to be resilient and act differently in different business environments, for example, in 2008, our top performers were companies like Amgen, Walmart, Bristol-Myers Marsh McLennan. These were the companies that did really, really well in our portfolio. Actually, we had three out of I think 10 positive companies in the portfolio. That year we also had companies like Amazon that didn't do well, Alphabet that didn't do well, Microsoft that didn't do well. 

Following year, however, Amazon was on the top. Alphabet was on the top. Visa was on the top, right? And we bought American Express during that downturn. That did very well. Similarly, in 2022, if you look at our top performers. They were companies like Vertex, Monster Beverage, Novo Nordisk, Schlumberger. And our bottom performers were Meta, Amazon, NVIDIA, Alphabet, and Tesla. You look at next year, the bottom became top performers. The idea is you don't build a portfolio with similar drivers so that they act in unison. 

And we see this in large cap growth space. When you look at our peer analysis. You either have managers that do very well in up markets, or they do very well in down markets. And we believe that's because, somehow, they have these screens at the very outset of investing, and they have screens for growth and valuation, and they end up having these biases that are implicit, that ends up creating a portfolio that either does very well in up markets or very well in down markets, but not in both. 

Actually, we analyzed this historically. We looked at all of our competition in the last almost 19-plus years that we have a track record for. There are almost 279 managers that have been data in databases. Out of those, we find 154 have a track record that's equal to ours like 19 years. And there are those managers that do better than us in up markets. They capture median 107% of the upside versus our 103% upside in up markets. But unfortunately, those group of managers are bottom quartile in down markets. 

Actually they capture 105% of the downside. It's very similar to the opposite. They capture 107% of upside but 105% of the downside. And actually that group again collectively is bottom quartile in down markets. If you look at our performance in down markets, historically our median downside capture is 91.9%, let's say 92%. 

And then there's a group of managers that do better than us in down markets. They capture instead of 92% they capture 86% of the downside. But there's not a single manager among those 25 managers that capture more than 96% of the upside, versus our 103% of the upside. And the reason is, again, they have biases, either very defensive or very aggressive, but not diversifying business drivers. So I think that's why our approach to risk and how we construct portfolios is a differentiator and, I think, in terms of being resilient in these up and down markets.