Splitting The Difference

We investors are a funny bunch.  We’re quick to find narratives and data that support our thesis, and ignore all else to the contrary. Or we’ll see the data, and thanks to our incredible overconfidence, simply state that the data may apply to the aggregate, but it certainly doesn’t apply to us. If 98% of investors should own simple portfolios of index funds, we’re the 2% who don’t need to.

It was decades ago that we all accepted that market-timing as an investment strategy had completely failed.  We engage in our favorite schadenfreude, directed at the newsletter writers and “death cross” moving average timers that blazed so brightly 30 years ago only to find their fortunes destroyed by a lengthy bull market.

And now recently, there is a growing consensus (finally) that stock picking doesn’t work either.  We have data ad nauseum that demonstrates that active managers regularly and consistently lose out to simple index funds, eaten alive by their own costs.  Across the global, across categories and asset classes, trying to identify which stocks will outperform is a fool’s errand. Active mutual fund managers who outperformed over the last five years have a miniscule chance of repeating that feat in the next five.

The odd thing about these revelations is that a great deal of investment professionals are willing to accept the data about market timing and stock picking and yet alledge that they can perform well with a combination of the two strategies.  Tactical allocation, global macro strategies and trend following all fall somewhere in the muddy middle between full-on market timing and stock picking.  These professionals seem to be willing to say “we can’t time the market, or pick individual stocks, but we can time groups of stocks.”  So they overweight tech and underweight emerging markets this month and overweight Treasury bonds and underweight Europe next month and are apparently wholly incapable of recognizing that this strategy is just a modified version of what we’ve already accepted as a failed strategy. Unfortunately I still see these “strategies” in client statements on a regular basis.  Clients whose advisors throw a mess of ETFs into their accounts and call it a portfolio, any profits they actually receive come as realized short-term capital gains amid a flurry of activity designed to look like an investment strategy.

The investing public has (rightfully) fallen in love with low-cost index funds and ETFs and now asset managers are exploiting this trend with a message that reads “Us too, and let me tell you how well we use these vehicles” as they promise to capture gains and avoid losses just like a newsletter writer from 1988.

To me, tactical/macro strategies are an expression of our unstoppable need to have control over our environment. The same pyschological bias that tells us we’re safer driving our car than flying in a plane (despite all evidence to the contrary) leads us to silly, overconfident investing.  We need to be in the driver’s seat.  We are convinced that we are a better driver than everyone else, and that statistics don’t apply to us. And so we tweak, time, rotate and stop-loss our portfolios instead of taking the materially safer route of a buy-hold-and-rebalance strategy.

It seems that tactical/macro investment strategies are the last stand of the performance-pitching investment manager.  History and research has taken away the promises of market timing and stock picking and those who earn a living by claiming the ability to outperform are left with rotating in and out of groups of stocks based on lines drawn on charts or P/E ratios or a funny feeling in your stomach or put/call ratios or  whatever is the metric de jour. Why one would believe that investment professionals can beat the market in this fashion instead and not the others is, quite frankly, beyond my rational understanding.

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