Investment Philosophy & Process

Financial markets offer exploitable inefficiencies.

Crescat’s edge is our ability to develop and profit from global macroeconomic themes. Crescat’s themes are robust narratives and supporting data based on deep research into the opportunities identified by our equity and macro models. Our proprietary models are built on value and behavioral investment principles. The models guide us to our themes. The themes are the real-world backstories that bring our models to life. We elucidate our themes in our quarterly investor letters. By discerning the richer narratives behind the securities recommended by our models, we believe we have an advantage over pure systematic quant managers.

A robust and repeatable investment process is critical to delivering strong absolute and risk-adjusted returns over the long term. Crescat’s investment process has persistently revolved around three key factors: global macro themes, value-driven models, and prudent risk management.

Global Macro Themes

Our goal in focusing on global macro themes is to provide investors and asset allocators with a unique source of high expected alpha with low correlation to common benchmarks and other managers over time. We believe that getting big-picture investment themes right is key to growing and protecting capital. By focusing on big macro investing themes, Crescat has anticipated and capitalized on many major events, including:

  • The US housing and mortgage bust in 2006-2008;
  • Oil bull market (peak oil) 2007-2008
  • Global financial crisis in 2007-2008;
  • Precious metals bull market from 2006-2010;
  • Oil price collapse in 2014 and 2015 and again in 2018;
  • Biotech run-up and bust in 2014-2015;
  • Rise of artificial intelligence from 2014 to 2017;
  • Demand for cybersecurity from 2016 to 2018;
  • China credit bust and yuan devaluation in 2015 and again in 2018;
  • Emerging market contagion in 2018; and the
  • US equity and corporate credit market downturn in 2018.

We provide transparency into our themes and the research behind them in our forward-looking quarterly research letters and monthly updates. We also publish research briefs on social media, foremost on Twitter, highlighting timely macro thinking and investment ideas. We strongly encourage you to follow Kevin Smith, CIO and Tavi Costa, portfolio manager on Twitter to see Crescat’s macro thought leadership in action. At Crescat, our model-driven macro themes shape the portfolios in all our strategies. Each individual security in our portfolios is an expression of a bigger picture trend or imbalance that guides our overall long and short exposures in our hedge funds. Crescat’s unique themes drive portfolio construction, diversification, risk modeling, and profit attribution to differentiate Crescat within the investment management industry.

Value-Driven Models

Crescat deploys proprietary, systematic equity and macro models that guide us to the themes and securities in our portfolios. Crescat’s discounted-free-cash-flow equity valuation (DCF) model has been an essential driver of Crescat’s long-term track record in all of our strategies since their respective inceptions: Crescat Large Cap (1999), Crescat Long/Short (2000), and Crescat Global Macro (2006). On a daily basis, our DCF model systematically scores, ranks, and values the 2000 most liquid global equities that trade on a U.S. exchange based on more than 50 underlying fundamental factors. Our DCF model scores stocks based on:

  • Six custom fundamental factor categories: quality, value, growth, fundamental dynamics, capital allocation, and balance sheet strength;
  • Four custom equity classes: defensive, growth, cyclical, and emerging growth; and
  • Three comparative, within-group analyses: all universe, class, and industry

The DCF model was originally developed in 1997 by Crescat’s Chief Investment Officer, Kevin C. Smith, CFA. He and his investment team have continuously refined it and applied it to managing money and producing alpha ever since. The equity model guides us to macro themes based on sector and industry aggregations that flag macro trends and imbalances for the investment team to flesh out and validate through further investigation. Crescat also deploys a variety of macro models to value and time the world’s major currencies, commodities, fixed income instruments based on a wide array of market and economic indicators which also lead us to themes. Both the equity and macro models discover mispriced securities with fundamental catalysts for change. Our models drive our investment decisions, triggering timely, well-supported entries and exits.

Prudent Risk Management

At Crescat, we believe in accepting a moderate amount of risk in order to realize the long term returns that our themes and valuation models are capable of delivering. We use a Conditional Value-at-Risk Model to monitor risk by position, theme, and overall in all of our strategies. Also, we believe in moderate diversification and hedging, including shorting in our hedge funds, as key tenets to reducing risk without sacrificing our return goals over time. We continuously strive to maintain a diversified set of high-conviction, model-supported themes and positions within the context of our risk model.

Crescat’s goal is to perform in the top 10% of active managers and significantly outperform the passive benchmarks over complete economic cycles. Our goal is high risk-adjusted returns based on statistics such as Alpha, Sortino Ratio, and Omega Ratio. We believe these statistics are better measures than the more popular Sharpe ratio for maximizing client utility over the long term because they help us focus on the goal of delivering positive, asymmetric returns compared to benchmarks. To understand why investors might prefer that we focus on delivering a high Alpha and Omega rather than delivering a high Sharpe ratio, as part of our risk management and risk measurement strategy, see this excellent white paper.

From a volatility perspective, Crescat’s strategies are designed for long-term investors who believe in Crescat’s time-tested investment process. They are not for short-term investors who are likely to be shaken out by inevitable and ongoing market vagaries that contribute to short-term pullbacks in Crescat’s performance. Given our valuation approach, we are confident that our portfolios are worth substantially more than the public markets are quoting them at any given time. Such conviction is key to withstanding short-term pullbacks. One thing that the partners of Crescat have learned in our investing careers is that it is perfectly normal for market and investor behavior to be frequently irrational and erratic. Such chaos provides a wonderful opportunity for long term success for those who can consistently apply meaningful investment principles. At Crescat, we apply value-oriented investment principles by feeding ongoing fundamental and macro data into our carefully constructed models to develop both themes and positions.

Embracing volatility in securities markets is important to realizing the strong returns that are possible from Crescat’s global macro themes and positions over the long term. Short-term losses are an indispensable part of our strategies. Investors need to be able to embrace a mindset that short-term pullbacks in Crescat’s strategies are not a permanent loss of capital or they will not be good candidates for investing with us. As value-oriented investors, we view volatility as our friend. It helps us to initiate long positions cheaply and short positions dearly and ultimately deliver strong appreciation. When the markets are working against our current holdings, our valuation principles give us the steady confidence that the intrinsic value of our portfolios is substantially greater than the current market price. As such, we believe pullbacks in any of Crescat’s strategies offer great timing for both new and existing investors to deploy capital. We work extremely hard in building our models and in researching, developing, and managing our themes and positions. We believe fortitude is a virtue and is one of our strengths, but it is also one of the strengths that investors must have to realize the ultimate value of our work. We seek like-minded clients with the emotional stability to counter and embrace market volatility along with us through complete business cycles.

Indeed, while we may make marginal sacrifices of positions for risk control to protect capital during adverse market conditions, we do not easily give up on core positions and high conviction themes. At the same time, we are humble enough to know that we cannot always be right. Thus, we maintain moderate diversification at all times. We test the strength of our investment hypotheses on an ongoing basis. When we are clearly proven to be wrong, we are happy to exit and move on. We know that the markets will constantly present us with substantial new macro themes and investment opportunities for future strong performance and that our models will guide us there.