Hybrid Investing: A Fresh Take on Portfolio Management for Retail Investors

As investors, we’ve attempted to fit ourselves into one of the two primary investment styles - active and passive. While both have pros and cons (discussed here), there is still much left to desire from both. Over the past several decades, conventional wisdom that investors could not beat an efficient market led to the rise of index mutual funds and then the boom of ETFs, and newer offerings such as robo-advisors have made constructing passive portfolios even easier and more tax-efficient; however, our view is that strict passivity leaves personalization and better returns on the table.

That is why we believe there is a sweet spot between active and passive portfolio management, which we call Hybrid Investing. Let’s dive in.

What is hybrid investing?

Hybrid investing is an evolution of portfolio management that is meant to combine the best of active and passive styles. Its primary focus is on building a solid diversified base portfolio with a high risk-adjusted expected return. On top of that, with the right insights, there is a tremendous opportunity to anticipate medium-term macro trends and incorporate those insights into an investment strategy while maintaining a mostly macro-neutral portfolio

Besides the lack of time and expertise, one of the primary reasons self-directed investors choose to passively manage their investments is assuming that over long periods of time, assets have positive returns. The downside is that by simply adopting this principle alone, they miss out on shorter-term opportunities that come from macroeconomic changes.

Though it might seem less risky to just let your investments sit, holding onto assets such as cash, bonds, and index funds, Hybrid Investing takes into consideration two important components in its attempt to achieve better risk-adjusted returns:

1. Building a solid core of assets that are more thoroughly diversified than the average portfolio on account of neutralizing the impact of fundamental economic drivers
2. Introducing a tilt in your portfolio to try to capture the upside of outsized returns caused by shifting economic conditions

At its core, it’s simply about being thoughtful regarding exposure. While any particular asset will have a myriad of exposures, these exposures can be balanced out across a portfolio by holding certain securities in relation to one another. For example, for any one security, inflation exposure may not matter as much as other factors, but because you hold a portfolio as a whole, the aggregated inflation exposure could represent a massive risk. Ideally, for every possible macro environment, you want more up than down.

This is the natural next step up from the traditional self-directed investor approach to diversification that spreads your assets into multiple categories, including asset class (stocks, bonds, commodities, real estate, etc.), sector (healthcare, tech, energy, etc.), and country. While roughly allocating across these categories allows for some diversification, you absolutely lose out on opportunities when not measuring your actual exposure to the underlying drivers and balancing them in a calculated fashion.

As an everyday investor, you might be asking why this is the first that you are hearing about this approach. It’s not new and is something in practice by the savviest professional money managers.

The only change is that now self-directed investors can take advantage of this Hybrid Investing style because of access to professional tools and data that have been historically only available to hedge funds and large institutions. Having the ability to understand how your portfolio is affected by macro drivers and adjusting it accordingly increases your opportunity to take advantage of medium-term trends and be protected against unexpected downturns. The truth is that while small-scale or individual-stock trades can seem random or, at the very least impossible to capitalize on more quickly than the experts, macroeconomic conditions trend over time and exist in markets large enough for many investors to benefit.

Like passive investing, hybrid investing is low-touch and allows investors to make small periodical adjustments every month or quarter and can be implemented with either funds or hand-selected securities. We believe that making these periodic adjustments will allow you to take advantage of medium-term macro trends, contributing to greater expected returns, and doesn’t necessarily involve taking on any more risk than you’re already taking.

Happy investing!