Intro to 5th Horizon

An Overview of our Process

Introduction

Welcome to Fifth Horizon! 

The following highlights some of our thinking about investing and a few of our portfolio construction techniques and gives a taste of what makes us unique!  Our team consists of several individuals, and while all of us are quantitatively minded and have been doing this for quite some time, we each bring an original perspective to modern equity investing.  Our core product is a quantitative long short equity strategy by which we aim to deliver equity exposure in a way that achieves meaningful, durable results over time.  It is an exciting time to be an equity investor and we are thrilled to welcome you to Fifth Horizon.

Quantitative Investing and Factors

Quantitative methods vary in sophistication, access to data, and computing resources, but at its most basic, quant investing is any process that leverages data to systematically sort investment opportunities.

The models which do the actual sorting use inputs called ‘factors’ to define the opportunity set of investments in rank order.  A factor is a source of return associated with a specific source of risk. The size of the return to a factor is consistent with the exposure taken.

As an example, research shows that "cheap" stocks tend to outperform expensive stocks over time.  As such, a formulation that identifies a "cheap" stock might be a 'factor' in a quantitative model; these stocks fit under the value factor.  Formulations that identify highfliers (the momentum factor) or those that identify solid companies with strong profitability and reasonable growth prospects (the quality factor) might also be candidates.

Taking exposure to one or each of these factors through a portfolio of stocks should deliver returns according to the return premium associated with each factor. These premiums tend to vary over time, and they do not each “work” at the same time.  Individual factor premiums will sometimes underperform and may even deliver negative performance for a time, this is the nature of risk premiums and is a requisite for the existence of positive payoffs over a longer horizon.  Said another way, taking risk cannot pay on net, over time if the risk is not in fact real.

For a quantitative model to be relied on in driving an investment process, the factors that define the model must be well-researched and founded on good economic theory.  A kitchen-sink approach that mines the data and weighs any potential return sources is not appropriate when prioritizing durable and meaningful investment returns.

A well-constructed quantitative process is powerful.  Subjective human biases that are the death of so many investment opportunities are vastly diminished in a quantitative approach.  Huge reams of data that would otherwise be impossible for even large teams of people to sort through are handled easily by quant investors.  Quantitative processes by nature are also highly adaptable quants can integrate new data, new understanding, and advances in technology with expediency.

Long Short

The core Fifth Horizon strategy is a quantitative directional long short strategy.  The quantitative piece is there to efficiently and effectively capture vast sums of data while mitigating biases.  We run a quantitative process because we want the opportunity to gain exposure to unique and durable return drivers without relying on our own capacity to predict the future in order to deliver meaningful results.

The inclusion of a short process in our strategy is yet another way for us to deliver on this hope.  The short book provides an opportunity to capture unique return drivers that may not otherwise be available to long-only investors.  In running a short book, we hope to access these unique return drivers while further diminishing the need to be right about the future.  The strategy is “directional” meaning that we have a long bias, we want to capture the generally upward trend in equity markets and so are net long in our exposure, but we also do not want to be overly concerned with market timing decisions or be caught in a style rotation.  The short book can protect the portfolio in down market environments, but it is also a wonderful place to capture unique sources of return.

The short side of the portfolio is intended to add value by itself but also will often hedge against market drawdowns, Fifth Horizon does not use extra leverage from the short book or anywhere else to increase market exposure.

The Special Sauce

Well-constructed factors matter.  A sound quantitative process will include factors which have been thoroughly researched, that have meaningful return premiums, and whose persistence can be justified under various paradigms.  When so much effort is put into building a single factor or even a set of complimentary factors (value plays very nicely with quality for example) it can be tempting to build and entire investment process around that factor. 

If the right factor exposure is chosen with the right timing outperformance is the reward.  Of course, this is impossible to do with any sort of consistency and thus the alternative, build a multifactor portfolio with some combination of the available return sources.  This might manifest as quality companies that are just kind of cheap, or cheap companies with just a little momentum, or quality companies with momentum that aren’t too expensive and that have a wave of positive sentiment behind them.  When attempting to build out the perfect combination it is quite easy to dilute the factor exposures and end up with a portfolio of companies that are mid-tier in every way.  Mid-tier exposures lead to mid-tier returns.

A different approach is to establish pure undiluted exposure to each factor within a larger portfolio.  The challenge here is that sometimes factors will “fight” each other, one will work while the other is crashing out and returns will again be mid-tier.  The ideal portfolio then consists of pure exposures to factors that are uncorrelated and that each have a positive return expectation. 

The special sauce then isn’t just in building and running the best factors.  There is substantial edge to be had in the way that a multifactor portfolio is ultimately constructed, in the way that each factor expressed in the portfolio in relation to the other factors that are there.  Good factors matter but a well constructed multifactor portfolio will also give consideration to how those factors work with each other. 

This is our aim at Fifth Horizon. We endeavor to build portfolios which have undiluted exposure to factors that are well researched, defensible, whose return premiums can be justified and are uncorrelated.  The result is an investment process which does not require a forecast, which is not conditional on a singular style bet or market call, and that delivers meaningful and durable returns over time.

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