The industry's move to systematic investment strategies explained.
Michael Batnick of The Irrelevant Investor cites statistics from SPIVA showing that 79.59% of large-cap managers have failed to beat their benchmark over the last 10 years and then makes these astute observations:
I believe the days of superstar stock pickers is a thing of the past. For many of these professionals, career risk is too large a hurdle to overcome. Straying too far from the index keeps their returns looking a lot like it and fees generally eat up any alpha they might earn. Aside from career risk, here are a few other risk factors to consider that can negatively affect a portfolio manager.
- Maybe they get divorced.
- Maybe they lose a key analyst.
- Maybe they go through a bad stretch and start second guessing themselves.
- Maybe they leave for another company.
- Maybe they want to spend more time with their kids.
This is just too many maybes and why I believe that if you’re going to deviate from the index, it’s important to do so in a systematic way. With quantitative strategies, you understand there will be times when it falls out of favor, in fact you sign up for that ahead of time. However, if a stock picker hits a rough patch, you don’t know if they will ever regain the ability it appeared they once had. Furthermore, it can be difficult to ascertain what caused them to outperform in the first place; that whole thing about distinguishing luck from skill.
When considering active strategies, it’s important for us that we’re not relying on anyone’s intuition, expertise, or mental or emotional well being. We don’t want our PMs speaking with management, doing channel checks or backing out the cash. We want them to follow their models with as little interference as humanly possible.
A focus on process over short-term results is a hallmark of DWA. We long ago recognized the need to systematize strategy decision rules in order to minimize the negative effect of human emotion on investment results. Part of the reason that we were comfortable with this is because of the mountain of research on momentum which suggests that momentum is a premier investment factor. With something that effective over time, why mess with it? Honing our craft is an ongoing process, but we take great pride in the level of consistency of our investment process over time.
Too often, our industry notes the percentage of active managers that fail to beat an index and comes to the wrong conclusion---essentially throwing the baby out with the bathwater. A much more telling statistic would be the percentage of systematic vs. non-systematic investment managers that beat an index over time. I suspect that the former number would be much higher than the latter.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.
