The Investor and The Accumulator rain death blows upon each other as they grapple for supremacy of the investing universe. Catch up on Episode I and Episode II, then read on as The Investor tells us why he fears not the market…
The Accumulator has just asked him why he thinks he has investing “edge”?
The Investor: Hah! Well to answer your question literally, I think I have an edge because I have the same faulty brain chemistry as everyone else, and thus have the personal exceptionalism bias, or whatever it’s called. (I’m sure you’ll remember…!)
Primarily, I guess I don’t think I do have an edge as much as I think most others don’t. If most other investors do worse than a few, than the few can win.
So to turn to the opposition: private investors first.
Obviously I don’t know every private investor out there, and have in fact only been exposed to a small subset through either real-life or through virtual forums. Some sound very good and plausible. But the majority of even the better sounding ones definitely exhibit, in my experience, what Oaktree’s Howard Marks calls first-level thinking – they think the obvious and forget the extent to which everyone else could also be thinking the obvious.
Instead, an active investor needs to think of the obvious and what everyone else thinks about the obvious (and why). And they also need to consider what the smart second-level thinkers think, so we’re onto third-level thinking, and so on.
Now, you might argue that even second- or third- or ninth-level thinking is (a) increasingly unreliable with each derivative and (b) discounted somewhere else by the market, and I’d agree it probably is.
But I’m pretty sure most of the amateur opposition doesn’t go much further than first-level thinking.
Note: I’m not even counting the downright bad stock pickers I regularly come across, who barely seem to engage in first-level thinking, who can’t do sums, who don’t read up on their companies, who over-trade, blindly follow tips, and so forth. They’re a huge bunch, too. Naturally they can win like dart-throwing monkeys – i.e. by luck – but obviously I wouldn’t bet on it.
What about the pros? When it comes to mainstream funds, I think a lot of them are constrained by issues such as benchmarking, herd mentality, and career risk.
In fact I’d say career risk is the biggest issue for them. It’s far safer to fail slightly than to fail big trying to win big, whether it be through stock selection, sector selection, market timing or anything else. They are incentivised as much not to lose as to win, in any given year.
The whole industry is structured that way. Hence the preponderance of those closet indexers – supposedly actively managed funds that basically mimic the market but charge investors much higher fees than our beloved true trackers.
In contrast, as a private investor I can buy what I like, go in and out of cash as I choose, and invest anywhere unconstrained by being told it’s not in some index or another. I can lose 50% of my money on a share and nobody needs to know.
Another group that sounds like are hedge funds, and it’s true they can do these things, too. But if they’re any good then hedge funds usually scale quickly to become lumbering and then are often just as inclined to keep assets as to keep trying to win as the traditional vanilla active funds we’re all more familiar with.
They also rapidly get shut out from the asset classes most likely to reward good judgement (if it exists) or most likely to offer higher return premiums (e.g. small cap value). And after all that they need to do well enough to pay for their eye-watering fees…
Then you have the passive crowd, who by definition aren’t playing.
So in my mind that’s a lot of the competition doing sub-optimal things.
Of course, the pros do have researchers and analysts and direct-market access and investigative journalists and the ability to lever up / down at will and so on and so on. Who knows if that negates the hopes I cling on to of a relative edge?
What about me? Am I wired differently?
Here I can say that I have evidence that I am. All my life I’ve been a bit different, have tended to offend by accident, am argumentative [I can vouch for this! – TA], am happy to hold unpopular views, and I’m not overtly emotional. I think all those things help.
I am also a bit OCD, in the correct (if very mild) sense of the term.
Since getting into investing, it’s the main thing I do. Other potential money-spinning ventures have largely gone by the wayside. I regularly read company reports at midnight, and check the latest stock market news at 7am, and thumb through investing books with my bacon sandwiches on a Sunday morning.
Is any of that enough to have an edge? Perhaps not. Perhaps the opposite. But that’s partly why I think I might.
I am not left-handed
The Accumulator: Wall St whistleblower, Charles Ellis, author of Winning The Loser’s Game said, “Don’t confuse facts with feelings.”
I hope you do have an edge, I really do, I’m kind of taken by your notion of your nippy little speedboat weaving under the guns of the ponderous battleships of Big Finance. But I don’t buy it – it’s too romantic. I’m glad you’re taking the risk, not me.
I think the bulk of private investors pulling shapes on The Motley Fool are neither here nor there. It’s the pros who account for the majority of the flows and that’s who we’re up against.
There are thousands of them out there and Lars Kroijer describes in detail their superior firepower: the astonishing access to information, analysts and computing power, and their first-name familiarity with the senior management of the stocks they follow. That section of Lars’ book is a fascinating insight into the enemy camp and it’s scary.
It’s interesting that you suggest fund managers are incentivised as much not to lose as to win… If the professionals have come to recognise that the best way to succeed is to collect the market return then maybe that tells us something? Sure, the private investor can lose big and only they need know, but they’ve still lost big! They’d probably be better off if they sacked themselves.
The paradox is that none of us can know until it’s too late. You need 20 years of results to prove you’re an investing ninja, by which time it’s too late if you’ve misjudged yourself. Again, it’s about the balance of risks.
I think it’s telling that many private investors don’t accurately measure their returns and costs over the long-term – why spoil the dream?
Now, don’t get me wrong. I definitely think you’re wired differently from most. Your resolve in the face of the cutest puppy amazes me. Your intellectual ability and investing knowledge is enviable. These traits set you apart from Main Street. I’m not sure you stick out so much in the City though.
That said, should you hit the jackpot, do remember I’ve supported you all the way. 100%. 😉
I am not left-handed either
The Investor: Thanks for the kind words – although I know you know me well enough that “you’re wired differently from most” is not entirely a compliment in my case. 😉
And I know the City is full of smart cookies. Doubtless many with (even! 😉 ) more intellectual firepower than me, but crucially I’m not sure that’s really what’s required once you can tie your own shoelaces and use a search engine.
All that said, I really wouldn’t be too in awe of the professionals. I’m not.
This article by Morgan Housel, for example, shows how useless analysts are when it comes to calling stocks. Now granted, analysts are screwed over by different incentive problems, career risk issues and behavioural biases than fund managers, but same sausage.
I’m heartened to read in Housel’s article that anyone following analysts would have done better by literally betting on the opposite of all their predictions, in aggregate. Many of these guys only follow a handful of stocks, in one sector, and they still can’t get it right, with all their money, research departments, water coolers, and lunchtime briefings with management.
You see that as daunting, and it is because it shows how hard it is. But it doesn’t show the professionals are any better than me at picking shares that will do better than other shares. Not to me, anyway.
Please don’t misunderstand – I think the pros are fearsome competitors. Your nautical parallels are nice, but the image that actually sprang to my mind was that scene from Terminator set in the future, where dozens of giant killer robots stalk a barren landscape, using flood lights and powerful weapons to zap the puny human resistance.
I’m not driving one of the robots in this image! But, equally, the puny human resistance lingers on…
Still, the horrible truth, as you correctly diagnosed last summer, is that I am addicted to this and probably would do it regardless. I think I have a good crack at beating the market, from what I know about myself and some clues from results to date.
To that end I’ve sent you some bits and pieces for trust and verification purposes, but I don’t want us to go down the road of printing numbers here. I won’t say I’m too humble (you won’t fall for that!) but (a) I don’t want to encourage people – I genuinely believe most people are better off in tracker funds, as I stressed at the start of our conversation – and (b) my longer-term returns data is as statistically robust as a Mori poll about promiscuity taken in a convent and (c) it could all be, until the day I die, luck.
Do I have an edge, or do I just have an addiction?
I am not sure. I don’t lose any sleep worrying about whether I’m taking an excessive risk (beyond the general risks of investing in shares and so on) by trying to add alpha, but I do spend fretful hours now and then wondering if it’s bad for my being.
We only get one life, and investing has become a bit of an obsession. The novel is looking even more unwritten than that of the average going-to-write-a-novel would-be novelist. Heck, I don’t even read novels anymore. I read annual reports. I don’t settle down or have kids – I churn my portfolio.
I don’t know if this is terribly sad, or if I’m lucky to have found a passion. I don’t really care about money the way a lot of people do. But I like loving something that I do, and I like keeping score.
Ultimately, as I said at the start, this is the reason why I actively invest. I will agree after all our chat that the possibility I might beat the market is clearly in the mix, but I still think it’s a means, not an end, for me. Which is pretty much the opposite of how it works for most people, for financial services, and probably for common sense.
In summary, please don’t worry about me. Edge or not, I’ll be fine. I think I’ve seen signs that I’ll do better managing my own money than any alternative, but the fancy word for clues that gamekeepers use to hunt deer is spoor, and spoor is basically sh*t. Which is about what those signs are worth so far, statistically speaking, and about what I’ll give if I end up 50% down from where I might have been if I’d never tried at all.
It’s only money.
All the best and Merry Chrismas!
The Investor
I would as soon destroy a stained-glass window…
The Accumulator: You are lucky to have found a passion. Passion is the most sustaining force of any human life. It can drive us on to great things. Whether you are lucky your passion is investing… we’ll find out in 20 years!
You quoted ISA millionaire John Lee recently:
In my view, to be a successful investor requires commitment and time, and you’re only going to put in the required effort if you find the stock market enjoyable and absorbing.
To be blunt, either you fall in love with investing – its fascination and its mysteries – or you don’t. You will know soon enough which it is.
This perhaps crystallises the difference between us. I enjoy it, but I don’t love it. I am comforted in my choice by the weight of evidence, academic research, and wisdom marshalled by the superstars on my team. You have a long shot at stupendous success and a slam dunk at doing something you love.
The important thing is that our choices square with who we are – investor know thyself – and I think you do.
Well, I feel like a British Tommy who’s just played an enjoyable score-draw with his Pickelhaubed Hun adversary in No-Mans-Land. It’s time to shake hands and withdraw to our respective trenches while the strains of Silent Night drift across the blasted field.
This is one struggle that won’t be over by Christmas, but I wish you a happy one all the same.
The Accumulator
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This was an interesting and entertaining mini-series. Thanks!
I’ve decided that The Edge I have is that I can be opportunistic, especially when it comes to avoiding tax.
Of course, that’s often not an edge compared to other individuals but it is compared to many professional investors. For example, I am a fan of the defensive investors at Personal Assets Trust and Ruffer Investment Company. But I can hold my cash at better returns than they can hold cash and Bills because I can use Cash ISAs and Index-Linked Savings Certificates. I can hold Index-Linked Gilts in S&S ISAs, where the income (and Capital Gains) will be tax-free. As far as I can see I can hold equities (in S&S ISAs and SIPPs) and gold on much the same terms as theirs. (If only I had a bank safety deposit nearby I could hold gold on better terms than them because sovereigns are free from CGT.) So I should be able to mimic their investment styles, but with a tax advantage. In a sense that’s active investment. I’d probably hold equities, though, largely in ETFs – and so you might call it passive too.
Another opportunistic trick I’ve used is to take a pension tax-free lump sum, and use it to help support us while my wife deferred her State Retirement Pension. That’s equivalent to buying an index-linked annuity at 10.4% p.a.: no professional investor could come close to that.
My main handicap compared to the professional investor is sheer ignorance of technicalities, and of what is available in the market. Tax savings more than compensate, I hope.
I’m guessing most people are somewhere in between these two states. I’m an income investor trying my best to reach my goal of £2K per month. This is via US, UK & Australian HYP shares, bunch of European & Emerging market dividend ETFs. Will add bonds in future when rates rise.
I find investing interesting but when I reach my goal of £2K per month, I do not really want to touch my portfolio unless I’m forced too (company takeover, bankruptcies, rights issue etc).
I very much follow Stephen Blands philosophy of “strategic ignorance”. Once you have diversified and selected the right shares, ETFs, IT’s based on yield, debt, P/E, P/B etc you literally ignore all the noise including capital fluctuations because no one really knows how that stock or industry will perform in the future. eg my BAE shares are up 50% and my YOC is 6.5% but I have no intention of ever selling. All my dividends are auto re-invested.
So although I’m using a semi-active or passive strategy, I’m aiming for a passive portfolio with minimal management.
Reg, Jon
Was certain “I thought it fitting, considering the rocky terrain” was coming at some point; but alas: my apparent edge as a “human IMDB” failed me….
This was brilliant! You’re obviously both smart funny and literate. Score draw I’d say….food for thought for the rest of us…
An enjoyable and amusing exchange of views! A great idea for this time of year.
I find behavioural finance even more interesting than investing. For what it’s worth, I describe myself as a passive investor with a simple portfolio with a very few active funds where I can’t find a UK-domiciled passive equivalent. My objectives are to stay ahead of inflation, keep life simple, retain flexibility and avoid paying high-rate tax in retirement!
“Am I wired differently? Here I can say that I have evidence that I am. All my life I’ve been a bit different, have tended to offend by accident, am argumentative [I can vouch for this! – TA], am happy to hold unpopular views, and I’m not overtly emotional. I think all those things help.”
Sounds like a description of me. BTW I score high on on-line tests for Asperger syndrome. These traits probably confer certain advantages such as being less likely to jump on a bandwagon and more likely to identify unusual investment opportunities and exploit them.
I’m tempted to defer my State Pension but because of circumstances too complicated to describe here I’d need to cash in some ISA holdings to do so. The break-even point seems to be surviving 10 years or so beyond the point at which you actually start drawing state pension. This ignores the opportunity cost of not having the State Pension during the years of deferment. If you were able to invest the State Pension which could have been deferred in an ISA and make, over the long term, tax-free returns in excess of inflation, then the break-even point recedes even further into the future. If like me, you’re a basic rate tax payer but at risk of becoming a 40% tax payer when the State Pension kicks in and certain assets are realised, then the tax-free status of an ISA becomes even more attractive. Now there’s a contrary opinion for you! Let me know if I’ve made a blindingly obvious error.
I did find a pretty trick on my wife’s deferring her State Retirement Pension. Tipped off by a comment on an MSE thread, I found that her occupational pension would pay her more while her pension was deferred. That’s the sort of thing I mean by calling myself an Opportunistic Investor.
I think that this thing about active investing vs passive investing is kinda over discussed. Personally, I believe that active investing is possible. Possible but not probable. There are people who are able to consistently beat the markets, George Soros, Warren Buffet, etc. However, most people can’t. Even if they try to emulate the same strategies, they will not get the same results. Thus, I think there really is nothing to discuss about. Few will be able to do it, many will not. Chances are, most of us are those who will not be able to beat the market.
But there’s a another question. If you know you cannot beat the market and you know someone who can, shouldn’t you invest most/all your funds into Berkshire? Berkshire in itself is a diversified portfolio. Meaning, chances are, if you invest in Berkshire, you should be able to beat the market.
Personally, I’m just a passive dividend investor.
This “series” is an excellent and creative way to explain the differences in philosophy between active and passive, thanks again!
I am currently half way between the two and I am moving towards passive as I get older.
However passive may not be as passive as it sounds. You still need to decide which index (or indices) to follow. Once you have done that you need to decide how to follow the index i.e. which fund or ETF.
For me there are also some big problems in tracking say the FTSE All Share which if you look at the constituents:
http://www.ftse.com/Indices/UK_Indices/Constituents_and_Weights.jsp
you will soon reach the decision that the FTSE 100 is such a powerful part of “All Share” that the others in the index are hardly meaningful (not withstanding the big chunk of big oil and resources in there). Of course that may change as the years go by but you are still stuck with the problem of such indices, the higher weighting also goes to the more expensive shares or biggest companies. As a value investor do I really want to buy into an index that tilts towards the most expensive shares? So although I use the FTSE All Share as a bench mark I do not have any products that follow it.
That raises another point, passive or active investors should all have a bench mark to compare their performance, even the great Warren Buffett does that! It needs thought to decide which one, I decided on the All Share but then I want to beat that market and perhaps I can do that passively. If I passively follow the All Share I won’t beat it, in fact after costs, however small, I am destined to lose and I don’t like losing! So I have been actively choosing passive products to beat MY bench mark! If I decide the Peru All Share Index ETF has the best long term chance of beating the UK FTSE All Share then why not buy some!
By the way it is perhaps worth mentioning why I choose the FTSE All Share as my bench mark. It was years ago when I questioned myself why I was paying 1% to Virgin Pensions for their FTSE all share tracker that I got started in investing. A large part of my initial SIPP pot came from that fund.
To finish off I would say that I also have a passion for investing, I read a lot and view a lot of investment related websites. This one is really World class, well done and keep up the great work!
Debates like this are great. After sticking my head in the sand and just saving cash, I’ve definitely been convinced that passive investing is the way to go.
I’m 31 and I have 13k as cash in a SIPP. I’m thinking about putting it all in the Vanguard LifeStrategy 80 accumulation units and updating any future payments to go in there to keep it growing. Does this sound sensible?
As I get older, I’ll just switch to the other Vanguard funds to reduce the equity %.
There is such a big range of definition of active and passive that I’m not sure it can be argued so easily.
For instance, with enough capital to maintain a core position via an ETF index — say, the IWM or, TNA if you want less cash-at-risk — and the willingness to do intraday screen-time, one could trade in and out of the TNA ETF, buying after dips — avoiding buying during panic selling — and either quickly selling partial positions into strength or building conservative short-term positions — if the market initially goes against you — awaiting eventual strength to sell into. This effectively lessens risk during big selloffs and compensates for less capital in buy/hold mode via the intraday(s), shorter term trading.
More screen time than most people want though. Useful to look at charts longer term to see how this idea “usually” worked.
Another way to go is many VERY small positions in momentum stocks (d0n’t be late to the party), some of it intraday, some of it longer term as positions quickly rocket up. Lots of small losses with this, but some very large gains as well.
Etc.
A fun series of posts. Shortly after reading, I came across an advert in the Hargreaves Lansdown newsletter for “The Big Deal, stock market challenge” (http://www.hl.co.uk/the-big-deal) and thought it would be fun for each of you to sign-up and pit a virtual £100,000 against each other. One going active, the other passive. Then I saw they support the concept of virtual companies and thought it would be even more fun for your readers to join up with either The Investor or The Accumulator for an active investing company vs. passive investing company friendly battle.
Granted it’s only for five months (starting 13th Jan), and not sure how you feel about associating Monevator with HL, but it sounds like a good laugh to me. Plus there is real hard cash to win.
A question for you both. Although dominated by huge companies which must be “analysed to death”, I judge that the pharma industry has a dismal outlook that is not yet “in the price”. Basically, they’ve stopped discovering useful new drugs, and they are permitted to sell many of their products only because of trial data that are, how shall I say?, of questionable honesty.
Suppose I am otherwise a passive investor: should I ignore my judgement on this matter? If I am an active investor, how should I best back my judgement? Remember, I am clear on direction, but haven’t a clue about timing.
Thanks for the feedback, and glad some of you enjoyed our attempt at doing something a little different. We might repeat next year, as this is a hard time of the year to find the time for “proper” articles. To which end, I am currently thinking normal service will resume with Weekend Reading on Saturday. 🙂
To follow up some of the feedback:
@Andrew — Cheers, you’re welcome!
@dearieme — I think opportunistic ‘edge’ of that sort is a different thing to investing edge, but I applaud you for being aware of it. Cash is a great example. Routinely you’ll see long-term studies peg cash returns at less than 1% in real terms, but until the financial crisis a private investor could do much better than that. I’m sure we’ll see that again.
@jon — That sounds like how I got started, so beware. 🙂 As you anticipate, a HYP can bring a surprising amount of forced choices with it some years, although I’m happy to say my demo HYP here on Monevator has been activity free once again in 2013.
@Andrew Kassen — So many choices… 😉
@Bobbyo — Too kind. Please inform our respective partners if you see them.
@Grumpy — Thanks, glad you enjoyed. I would have to defer to others on the intricacies of the state pension. I have made a deliberate decision to kick thinking about that into the long grass for another decade on a personal basis, given how much it changes, though I concede the time may come before that when I need to get up-to-speed for Monevator purposes.
@earlyretirementsg — Agree with most of that. Of course, we don’t know that Warren B *will* still beat the market, we only know that he did. So for my money, investing in Berkshire is very much an active investing choice, albeit at the passive end of the spectrum. (Personally I owned it for a while when it was trading around book value a couple of years ago, but I don’t currently.)
@China — Thanks for the generous comments, and also for your interesting thoughts on benchmarks. I think this is a bigger deal than many think. For example, some say our model lazy portfolio here in Monevator is not performing because it has lagged the FTSE 100 but when that is just a fraction of its equity holdings (and with a huge slug in fixed interest), is that really an appropriate benchmark? On the one hand of course not. On the other, the FTSE 100 is a cheap and easily investable alternative. There is no good answer to this issue, only different compromises.
@Mr Lazy Investor — Thanks. As to your plan, we can’t give specific advice but yours seems a pretty sound strategy to me. 🙂 One of the only downsides of the LifeStrategy funds — and any single fund approach — is they don’t give you much chance to use up your capital gains allowances, but that is an esoteric concern for most. Personally, I would also split my money between at least two companies (i.e. fund managers AND Sipp providers) because I am very paranoid. 😉 If I had to pick one fund company it’d be Vanguard, but…. you never know for sure.
@Mike — Well, those are all active strategies. So if you follow them you’re an active investor. I agree it’s a different approach than stock picking, of course.
@CisforV — Glad you enjoyed the posts. I have nothing against Hargreaves Lansdown at all, but I do have qualms about a stock picking competition with a five month time horizon. If I was entering that — with no downside as it’s not real money, and a need to score big to win — I’d just pick some beaten-up ultra-volatile companies and cross my fingers. That hasn’t got much to do with real active investing, IMHO.
@dearieme (again!) — If you’re a passive investor, I would ignore your qualms entirely. I could start to argue against your view (I think it’s a dozen years too late, I’d point to tobacco stocks as an interesting case of similar cashflow beasts who have done well with declining markets and gloomy outlooks, I think big pharma companies have thousands of staff at least as aware as you and me of whatever risks they face, and have billions to try to surmount them, etc etc) but this isn’t really the place for that. As a passive investor, you’d just buy your index and get on with life.
If you were an active investor you might decide not to own the shares, you might short them, you might own rivals (somebody is going to be making money out of soaring demand for healthcare even if you’re right right and these don’t) and so on. Skies the limit, really.
Thanks to both of you for another year of excellent and useful posts.
For a moment… I thought you were going to “show us the money there” The Investor… I read above your reasoning why not… Could we at least ask if you “beat the market” … which market I hear someone cry… in 2013?
A short to medium time period conceded but something for us all to chew on…?
@ Grumpy – I think you’re spot on re: the pension.
@ China Nigel – A global portfolio (picked to mimic global capitalism’s allocations to investible stocks) would suggest an 8% or so allocation to the FTSE All Share. Using the sum of the world’s investing knowledge is a reasonable way to guard against overweighting a particular country or sector. My own portfolio is globally diversified and so will beat the FTSE if the rest of the world beats it. It’ll lag if the FTSE beats the world. You’ve got a good chance of beating the FTSE if you tilt towards risk factors like value and small cap too.
@ Early – Warren Buffet himself has said it’s now much harder for Berkshire to emulate its past performance because it’s so big. Berkshire now moves the market. Also, how much longer will its current manager’s remain at the helm?
@ Jon – Yes, I think you’re right, many people will blend a personal investing strategy from the tenets of active and passive investing. Passive investing in particular requires such iron discipline and runs counter to the natural human instinct for action that it’s hard for people to believe they can’t improve it.
@ All – thanks for your comments – supportive, critical, questioning, funny and thought-provoking as always.
Great read! I have no ‘Edge’ investing is not my passion, my family, sport and a social good pint (real ale) are that, the last 2 are interchangable:) The end goal is my aim i.e. the safest way to accue a tidy retirment income. How I get there doesn’t excite me, only that I do. Your writings and suggested reading help me to do that, thank you.
Active learner, Passive investor 🙂
Great article!
I think ultimately for 99%+ of people index funds are clearly the way forward as the evidence for fees eroding performance over time is overwhelming and to get edge in markets requires alot of hard work which most people are not prepared to do/interested in.
It seems to me however if investing is your full time job/passion and you are putting many hours a week in, the likelihood of market out performance is high. In large caps, the amount of money that is passively managed (either via index funds or via closet indexers) is huge relative to the size of the market and this leaves a lot of opportunity for out performance for those not constrained by those having to match an index. In small caps, the advantage to an individual investor is huge because the size of investment will not move the stock price. A small cap money manager is losing several percentage points on execution alone if he tries to put on a meaningful position. This problem of slippage also occurs in hedge funds managing large amounts of money in large caps.
I would also argue that the internet has been a massive leveler of information asymmetry. The information available at ones finger tips today would be something even the likes of Soros and co could have only dreamed of 10-20 years ago.
So what edge do the big guys have versus the small guys? Man hours. What edge do the small guys have over the big guys? Far better execution costs (because of no slippage), unconstrained investing. I think the small guys have the advantage.
So I certainly think for someone going at it full time, there is very decent edge to be had, over both index tracking strategies and even the hedge fund and money manager community.
Hmmmm… You should do this again after a big market sell off with lots of fear and uncertainty. The problem at the moment is that both active and passive investors have generally done well and the market’s relatively calm so it’s easy to get into a, ‘you’re so pretty, no you’re so pretty’ type of backslapping conversation at the moment.
Active investing is typically represented, especially by passive investing adherents, as being about beating the market. I don’t think it has to be, it can be about investing for income and value with a relatively low beta so that in the years when passive, index tracking investors have shocked looks on their faces the “active” (how active?) investor can be relatively happy.
You can even turn passive investing into an attempt to beat the key index benchmarks e.g., the S&P500, if you allocate to only some index subsets.
I think “The Investor” mentioned it but it doesn’t have to be either or, all or nothing in any type of strategy. Human beings seem to have a general tendency to dislike the middle road and focus on extremes.
I agree with Willem’s points. We are in a period of an historically unusual lack of bigger selling periods. In “the old days” semi-frequent 10% pullbacks were normal.
One of the things that passive investors are exposed to are (infrequent, yes) black swans — some of which are devastating — and of course, just an overall period of market malaise. Now, there is “no” risk in the market. 🙂
==> Mike McCurdy: Surely every investor is exposed to black swans? I think that what you are saying is that active investors can be more flexible and can in principle react, but surely the evidence suggests that even professional active investors don’t always do so? Or did I misunderstand your meaning?
==>Willem de Leeuw: “…so that in the years when passive, index tracking investors have shocked looks on their faces the “active” (how active?) investor can be relatively happy.” Again, an active investor can be happy in this case, but there is evidence to suggest that most active investors don’t achieve this. Once again, I am learning here, so I’m not sure that I’ve fully understood your meaning.
==>Everybody: I find these discussions very interesting and informative. Thanks.
@ Willem – what you’ve just described – low beta in down years – sounds a lot like beating the market to me. How happy would you be with low beta in up years?
I don’t think either The Investor or I gloss over the market’s propensity to bite investors in the behind just when everybody thinks they’re going to be rich. Do have a dig around the site and see for yourself.
I agree with your third and fourth points – see previous comment.
Passive investors aren’t the bear market patsies that you and Mike portray. We accept that downturns are inevitable and thus use diversification, rebalancing and a long-term perspective to ride it out. If you’re going to be devastated by a market downturn then put more of your portfolio in bonds.
Where many active investors come to grief (though not all of course) is that they believe they can see it all coming.
Thanks Andrew – a certain type of active investor, one who is putting in a fair amount of screen time with intraday index’ed ETF trading to take advantage of daily market movement and is maintaining a lesser amount of buy-and-hold inventory, would be less exposed to overnight/day mega-disasters; the sort of — hopefully highly unlikely — thing that would crash and close the markets and make for few buyers when they reopened or ….. just the run-of-the-mill black swans like economic depressions or power grids getting knocked out for extended periods. Unlikely events but ones that provide quick portfolio haircuts that kill years of profits in weeks or months.
Part of my investment/trading philosophy is keeping long stock inventory at a lower level than most. But the not fun part of compensating for that is the intraday screen time with ETF’s.
Fantastic series of articles eloquently outlining the respective advantages of active and passive investing. I found myself awarding a victory on points (by a midge’s widge) to the Accumulator but you have to love the chutzpah of the Investor.
Thank you for your content over this year TI and TA and for this excellent series.
My take is that active investing can be rewarding. In particularly, empirically, Small-cap and Special Situations. Why? Perhaps because the market misses something. Perhaps, as some great comments above point out, it is difficult for institutions to fully reap rewards in these areas.
My late father’s “edge” was to invest in companies he thought would be subject to an acquisition or merger. His record was outstanding. Unfortunately, I have no idea how he managed.
I suspect the answer is time (and discipline). Us individual investors have as much time as we are willing to put aside. Our sparring partners in the industry do not have such a luxury. They are at the whims of their institutional backers who can pull funds at the drop of the hat (as to many CEOs at blue-chip companies).
The biggest difference I see between TA and TI is where they devote their time. TI seems to love looking into and investing in stocks. TA seems to be the ultimate bargain hunter looking for cheapest way to batter his fees down.
@OldPro — Nice to hear from you, it’s been a while! 🙂 There’s a reason why I’m not going into detail in the article or here, which is that I think such information is dangerous as well as useless.
Okay, so I was nicely up against all the major indices in 2013 except Japan, even in local-currency terms. But what does that tell anyone? You don’t know how much risk I took to get my results. You don’t know if I used leverage and you don’t know what my asset mix was. Perhaps all I owned all year were shares in Facebook (Note: It wasn’t!) and that determined my entire alpha!
After several years reflecting on this, I think I’ll only go deeply into writing about active investing on Monevator via some kind of paid-for subscription service, if I ever do anything at all. Such an offshoot would detail the ‘complete package’ — asset allocation, general views on market etc — for what it’s worth (which may not be much!) and crucially would not be at all accessible to people just randomly coming across this website, most of whom should be passive investing anyway.
I wouldn’t hold your breath on that, but if the banner advertising market continues to deteriorate it might be the only viable way to ever really make writing about investing pay — and hence to fund the time/effort that goes into the wider passive preaching, too! 😉
Happy new year to all readers!
Thanks both for the interesting article. I’m almost all passive now (mainly due to reading Monevator) but I identify more closely with the Investor personality-wise. No wonder I keep accidentally causing offense in the comments!
You talk mainly about share picking versus buying passive funds, but I would have thought asset allocation would make a bigger difference – or is that itself part of the definition of active/passive?
E.g if you decide to hold 0% bonds and 100% equities in a given year then isn’t this much more significant than the decision to pick stocks rather than buy a passive fund? Or does it even out over the longer term?
A very interesting discussion. I’m in the Investor’s camp, but would class myself as a very passive active trader. Most years I manage only three or four trades. Having a fairly diversified portfolio, I’m content to leave well alone most of the time and just live off the income plus a cash in or two up to the CGT allowance. However if a good idea comes along, either my own or something I’ve come across, then I can’t resist the temptation to back my hunches and with a significant amount of money too. I’m not one to pore over the books of companys, so in a sense it’s just pure gambling. I find that flashes of inspiration for good investment opportunities come along pretty infrequently, so I need to take full advantage when they do. So far, this strategy of passive investing with the occassional significant side bet seems to have worked just well enough to justify continuing with it.
This is epic! As usual to me, I’m siding with the Accumulator (and Bogle). I don’t have the time, the will, or really the balls to try to win this game against such strong odds. But hey, I hope both of you keep up the good work and find continued success.
Brilliant back and forth and very entertaining!
I can see the argument for both sides as it is each to their own, but I can’t see many investors having the passion and time to make active investing work for them. I certainly won’t even be attempting it anyway!
Really enjoyable read! I am someone that started investing in 2019. You can’t argue with the sheer pragmatism of the passive approach but unfortunately I identify with some active investing for the lure of outsized returns.
Do you have views on combined approaches- e.g. majority of funds in passive indexes vs. a percentage in active bets? Personally I target a 65/35 split. And if you’re active investing globally, what do you benchmark against? FTSE All Share world? S&P 500?
Come very late to these articles, after link in this weeks.
Active vs. Passive is a continuum and my approach uses both.
@Ziggy I use a similar approach ratio to you, but I do vary mine by asset class so I hold property REITs, Infrastructure, Renewable Energy and Private Equity these are all 100% Active. My Defensive Allocation is almost 90% Passive Bonds and my Equity Allocation is about 70% Passive. I benchmark the actives vs. an appropriate benchmark for each investment. I nominally use FTSE World as a benchmark for my portfolio as a whole.
Maybe I’m being sensitive but I think that @TI is a bit harsh in “We know they almost certainly would have done better with passive equivalents, but they may not and they probably don’t care.” Why is Active more sensible when you choose individual stocks vs. a pooled investment?
For example I hold five Global Active IT’s, all have low (for active) fees, three of them have beaten the Passive Global approach, over 3,5 and 10 year time frames. The other two I’m prepared to stick with because, I know that they have other benefits (rising income) / EM diversification, which I’m still currently able to justify to myself.
Hang on, the sentence quoted says one thing and then you ask a different question. 🙂
The majority (i.e. more than 50%) of money in active funds loses to the market after fees.
This isn’t an opinion, it’s a mathematical certainty:
https://monevator.com/is-active-investing-a-zero-sum-game/
As to your question, it’s true I do think this (and I’ve possibility insinuated it somewhere else in the article, to be fair. 🙂 )
Basically I think if you have edge, then you can probably pick stocks better than you can select the minority of winning funds. And if you can pick stocks then you don’t pay the fees on the funds. So both these things combine to mean I believe passive is best for most people, followed by stock picking for the few who have edge, followed by funds for those who must be active but don’t have edge.
Does that mean some funds won’t beat the market? Of course not, we know they do.
But the overwhelming majority fail to over time:
https://www.etf.com/sections/index-investor-corner/swedroe-losers-game-reaffirmed
The fact that 60% of your active ITs have beaten the market and 40% haven’t doesn’t change this.
You might have edge, you might have been lucky. But it’s anecdote.
The comprehensive results as measured by SPIVA reports and other evidence — and the axiomatic maths — makes active investor *for most* a losing game. 🙂
As always @TI thank you for taking time to respond. I love just discovering new articles on monevator not seen before. The quote was talking about pooled funds and then you indicated a preference for stock selection. I did also say I might be, being sensitive 😉
I agree with passive is best for most, but I do think there are different types of “edge” or thinking you might have an edge 🙂
I definitely know, I have no edge when it comes to selecting individual stocks and agree that the majority of funds will loose, but maybe I can pick some of the ones that will not? I do think it’s possible for me / average investor to select themes that may give them an edge. I’m not convinced that ETF’s are the best way of doing this:
https://monevator.com/sectors-themes-megatrends/
I think for me it’s easier to select ITs whose managers specialise in the “tilt” I may want to take e.g. rising income, new / emerging economies / technologies, a region, smaller cos.
Not all decent active managers have excessive fees, one of the best performing Trusts for me, fee is less than 0.5%. I prefer trusts because of the amount of information available. Even @TA has used an Active fund in the ‘S&S’ portfolio.
I also don’t want to ignore private equity in my portfolio, so this has to be active and some sectors, again I think just suit active e.g. property, renewables (this was partly for environmental reasons, but alternatives have reduced volatility in my portfolio). On the other hand my gilt allocation is 100% passive.
As I said 70% of my equity allocation is in ETFs, so passive is definitely my core. But over the last 10-12 years, since I have been investing I have enjoyed (as you do) the active choices / research and I have beaten my benchmark.
@Whettam — Congratulations on your success to-date and you clearly have a strategy that’s working for you. As I said, I don’t deny edge exists or that some funds beat the market. Remember, as this debate stresses, I’m an active investor, too!
I suspect @TA would agree with you and put active funds above stock picking. I’ve seen people fail at both, in as much as they kept records (it’s easier to tell with amateur stock pickers because even their reasoning is usually faulty) and I have friends who have done well with funds, almost always because they got into a particular fund or trust that went to the moon. (E.g. Scottish Mortgage). Which is fair enough, but doesn’t change the odds.
I was just responding to the suggestion that I as being harsh when I stated: “We know they almost certainly would have done better with passive equivalents, but they may not and they probably don’t care.”
I wasn’t being harsh. I was being accurate, according to all surveys and the zero sum nature of investing. 🙂
Glad you’re enjoying the archives. Would really love to find more ways to get people to delve around down here!
You are doing a great job highlighting the older content, only found this because of the link in today’s article.
This is another piece that I reread just like it was yesterday, recalling when doing so the wry smile that I had at the beautiful turns of phrase used when I first read it. But then I have to recheck the date on the piece in momentary disbelief that – yes – nearly ten years really have passed.
The split in the approach to investment between @TI and @TA runs through my own psyche like a railroad track. But, unlike @TI, I’m not interested in trying to pick out companies, funds or investment trusts. I know that I’m hopeless at that and that for me it’s a sure fire loser’s game compared to just choosing a one stop shop tracker like VWRL. That’s not to say that I won’t pick up a single percent or two allocation here and there for a trust on an especially oversized and unusual discount. But doing so is just scratching an itch, not addressing the main course. What drives my own interest are systematic alternatives to market capitalisation weighted index tracking and to equity / bond mixes. So, that’s the value factor, quality / gross profitability factor, low volatility, size and momentum factors. Above all though, its relative and time series intermediate duration (3 – 12 month) momentum, especially of the concentrated and multi asset class varieties. Basically, trend following on steroids. If you’re going to chase performance, then make a virtue of it, do it consciously, and follow a rules based system based upon evidence. Looking at the past performance (and allowing for implementation necessarily being a total nightmare, and fraught with many complications), it’s still by far and away the absolute stand out for total returns over the long haul. To paraphrase Michael Cane, historically, it ‘blows the doors off’.
Glad you enjoyed the piece all over again, TLI! How have you found managing the psychological side of factor investing when much of it has failed to live up the promise?
Thanks @TA: I think it helps, in terms of reactions to and feelings around both out and under performance relative to a market cap weight benchmark, to view the Fama-French factors as an alternative way of weighting and selecting securities or assets more broadly within what is arguably still, overall, something of a ‘passive’ framework – i.e. the rules select a broad swathe of companies to index (it’s just not by market cap). You’re not using any personal judgment when analysing companies, nor responding to company or sector specific narratives. Rather, each factor ETF’s specific rules systematically buy and sell what they do based only upon predefined criteria and constraints around value, momentum, size or equal weights, liquidity, low volatility or quality.
It also greatly helped that I was lucky (in terms of sequence of returns) to have had great run of performance with the former Vanguard UK momentum ETF, until they abruptly closed it for seemingly no good reason whatsoever.
On the other hand, their former value, liquidity & low volatility offerings ranged from OK, but underwhelming, through to significantly lagging (value). I was in those too until they also closed them at the same time without much warning.
IMO the least that one can reasonably say in favour of factor ETFs is that they can help provide some style diversification benefit within a broadly defined passive framework and that, in principle, the current crop of multi factor ETFs may also deliver some degree of ‘rebalancing’ bonus between the factors without any need for investor activity.
The frustration for me comes from the, IMO, very poor design and inherent implementation and definitional issues both with factor ETFs specifically and factor investment more generally.
It’s difficult to even begin to summarise these problems in a comment box here, but the conclusion that I’ve reached is that the technical implementation shortfall for momentum ETFs is chronic compared to the potential offered.
In particular (and this is very much non-exhaustive, illustration only):
– There’s what (at comment #28 on your “Momentum – the fickle factor” piece) I call the ‘homeopathy’ issue; namely that factor ETF providers try to gain exposure to the relevant factor whilst at the same time maintaining a very large number of companies to invest in by having only weak exposure to that factor. Explain that one to me! If you look under the hood of these factor ETFs, which one definitely has to do, then they very rarely hold more concentration than just the top 30% of all companies measured by the individual factor metric in question, i.e. for momentum only the top 30% by cross-sectional momentum. Frankly, what sort of exposure are you getting when it’s as dilute as 30%? It’s same flaw of reasoning as with homeopathy – less does not equal more, it just equals less exposure to the factor and, therefore, less opportunity for differential performance as compared to market cap weight benchmark.
– The look back and holding periods are probably a little bit too long in the ETF’s available. It is debatable, and it depends on how exactly you choose to cut the data and what datasets you choose to look at, but both generally for momentum and especially within the US large cap space, momentum has been trending towards the shorter end of the intermediate (3 to 12 months) spectrum; and so more weighting towards 3 and 6 months lookback and hold should do better now than for 6 and 12 months.
– The factor ETFs available don’t do anything really to avoid the inevitable front running from hedge funds. They’re lambs to the slaughter when it comes to their preset and announced rebalancing dates.
– Where are all the cheap multi-asset UCITS momentum ETFs? There’s basically none out there. Momentum is cross asset class in nature, so it’s badly sub optimal to confine exposure to equities alone. The only way for retail to gain exposure to multi-asset momentum, other than DIY of course, is via either high cost funds (with 25% performance fees off of undemanding high watermarks, e.g. MontLakeDunn) or from the likes of Winton Trend, with only very short performance histories. And, at least as far as I can tell, these offerings aren’t particularly concentrated in their approach and basically just aim for low correlation consistent returns rather than for a maximised total return. That’s all well and good for those purposes, but not for substantial outperformance which, IMO, likely necessitates taking on more concentration risk (albeit a risk which in these funds is systematically selected and hopefully diversified across different asset classes). This type of broad based / diluted time series multi asset trend following momentum is unlikely to make you rich. Hurst, Ooi and Pedersen in The Journal of Portfolio Management (“A Century of Evidence on Trend-Following Investing”, Vol.44, No.1, Fall 2017) give performance figures for Jan 1880 to Dec 2016 of 18% p.a. excess return gross, 11% p.a. excess return gross of fees but net of transaction costs, and 7.3% excess return net of both transaction costs and of an assumed 2%/20% hedge fund type fee. The excess here is in terms of the excess over and above the ‘risk free’ interest rate (I assume short duration T-Bills) available over the period.
– To really outperform I think you also need to use more sophisticated measures of momentum, e.g. “13612W accelerating momentum” (1, 3, 6, 12 month lagged return each weighted to its annual return, so with weights of 12x, 4x, 2x and 1x respectively).
– Trend following and momentum also work best in low volatility environments and so factor exposure should really be scaled and timed to volatility (i.e., for US equities, using the VIX for the SP500 and the VXN for the NASDAQ100). Using the MA200 of the VIX and the VXN also can potentially help to give a forward view of volatility, as price continuation, to an extent, lags volatility continuation. In the comments on Finumus’ first LETF piece, I’ve just included a link to an SSRN paper (Charles Dow prize 2016 award winner) on using MA200 with the SP500 and 1.25x, 2x and 3x leverage in order to target low volatility environments.
I could go on & on here because, frankly, I’m a bit obsessed with momentum. Einstein described compounding as the world’s eight wonder & momentum’s a bit like that. Once you start thinking about it, it’s hard to stop. It’s also got some huge overlaps with Cut Losses Let Profits Run, although there are points of difference too. My own career has nothing to do with finance, so I guess this shows I’m probably a frustrated wannabe amateur quant!
Haha. Colour me unsurprised that you have dived deeply into this 🙂
I don’t think we’ll ever find a retail momentum ETF that meets your requirements! What would you prescribe as a momentum reading list for me and any others who are interested in devising their own strategy?
Thanks @TA.
I’d start with Elroy Dimson’s 2008 paper on SSRN “108 Years Of Momentum Profits”, then have a look at the paper (2016, revised 2021) by Michael Gayed on his Leveraged SP500 ETF strategy using the 200 day moving average to try and miss high volatility and which has a 92 year long backtest (the link to which on SSRN I’ve added to Finumus’ LETF piece comments section) and then move onto what, IMHO, are the two main non-paywalled canonical lists for, respectively, momentum more generally and for dynamic asset allocation and momentum (taken together) more specifically, namely:
– the AQR Bibliography On Momentum; and
– the Two Centuries Investments (Mikhail Samonov) list:
Here’s the AQR list sorted by author:
Asness, Cliff, 1994, “Variables That Explain Stock Returns,” dissertation, University of Chicago
Asness, Cliff, 1997, “The Interaction Between Value and Momentum Strategies,” Financial Analysts Journal 53(2), 29–36
Asness, Cliff, Burt Porter and Ross L. Stevens, 2000, “Predicting Stock Returns Using Industry-Relative Firm Characteristics,” working paper, AQR Capital Management
Asness, Cliff, John M. Liew and Ross L. Stevens, 1997, “Parallels Between the Cross-Sectional Predictability of Stock and Country Returns,” The Journal of Portfolio Management 23(3), 79–87
Asness, Cliff, Tobias J. Moskowitz and Lasse H. Pedersen, 2013, “Value and Momentum Everywhere,” The Journal of Finance, 68(3), 929–985
Barberis, Nicholas, Andrei Shleifer and Robert Vishny, 1998, “A Model of Investor Sentiment,” Journal of Financial Economics 49(3), 307–343
Carhart, Mark M., 1997, “On Persistence in Mutual Fund Performance,” The Journal of Finance 53(1), 57–82
Chan, Louis K.C., Narasimhan Jegadeesh and Josef Lakonishok, 1996, “Momentum Strategies,” The Journal of Finance 51(5), 1681–1713
Daniel, Kent, David Hirshleifer and Avanidhar Subrahmanyam, 1998, “Investor Psychology and Security Market Under- and Overreactions,” The Journal of Finance 53(6), 1839–1886
Fama, Eugene F., and Kenneth R. French, 1996, “Multifactor Explanations of Asset Pricing Anomalies,” The Journal of Finance 51(1), 55–84
Fama, Eugene F., and Kenneth R. French, 2008, “Dissecting Anomalies,” The Journal of Finance 63(4), 1653–1678
Frazzini, Andrea, 2006, “The Disposition Effect and Underreaction to News,” The Journal of Finance, 61(4), 2017–2046
Griffin, John M., Xiuquing Ji and J. Spencer Martin, 2005, “Global Momentum Strategies: A Portfolio Perspective,” The Journal of Portfolio Management, 31(2), 23–39
Grinblatt, Mark, and Bing Han, 2005, “Prospect Theory, Mental Accounting and Momentum,” Journal of Financial Economics, 78(2), 311–339
Grinblatt, Mark, and Tobias J. Moskowitz, 2004, “Predicting Stock Price Movements from Past Returns: The Role of Consistency and Tax-Loss Selling,” Journal of Financial Economics, 71(3), 541–579
Grundy, B.D., and J.S. Martin, 2001, “Understanding the Nature of the Risks and the Source of the Rewards to Momentum Investing,” The Review of Financial Studies 14(1), 29–78
Hong, Harrison, and Jeremy C. Stein, 1999, “A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets,” The Journal of Finance, 54(6), 2143–2184
Hong, Harrison, Terence Lim, Jeremy C. Stein, 1999, “Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies,” The Journal of Finance, 55(1), 265–296
Hvidkjaer, Soeren, 2006, “A Trade-Based Analysis of Momentum,” The Review of Financial Studies 19(2), 457–491
Jegadeesh, Narasimhan, and Sheridan Titman, 1993, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” The Journal of Finance 48(1), 65–91
Jegadeesh, Narasimhan, and Sheridan Titman, 2001, “Profitability of Momentum Strategies: An Evaluation of Alternative Explanations,” The Journal of Finance, 56(2), 699–720
Lee, Charles M.C., Bhaskaran Swaminathan, 2000, “Price Momentum and Trading Volume,” The Journal of Finance, 55(5), 2017–2070
Moskowitz, Tobias J., Mark Grinblatt, 1999, “Do Industries Explain Momentum?” The Journal of Finance 54(4), 1249–1290
Rouwenhorst, K. Geert, 1998, “International Momentum Strategies,” The Journal of Finance 53(1), 267–284
Rouwenhorst, K. Geert, 1999, “Local Return Factors and Turnover in Emerging Stock Markets,” The Journal of Finance, 54(4), 1439–1464
Here’s the Samonov list which is sorted by year (all the SSRN stuff should be free to access and to download from SSRN as a PDF, and both those and the other sources that I’ve listed below are available to access via the links in the version of the list on Samonov’s website):
Arnott, Robert D. and James N. von Germeten, 1983, Systematic Asset Allocation, via Research Affiliates
Perold, Andre and William F. Sharpe, 1988, Dynamic Strategies for Asset Allocation, via FAJ
Sorensen, Carsten, 1999, Dynamic Asset Allocation and Fixed Income Management, via JFQA
Berkelaar, Arjan B. and Kouwenberg, Roy R. P., 2000, Dynamic Asset Allocation and Downside-Risk Aversion. Econometric Institute Report, via SSRN
Bajeux‐Besnainou, Isabelle, James V. Jordan and Roland Portrait, 2003, Dynamic Asset Allocation for Stocks, Bonds, and Cash, Journal of Business
Pola, Gianni and Giordano Pola, 2006, Optimal Dynamic Asset Allocation: A Stochastic Invariance Approach, via IEEE
Basu, Devraj and Hung, Chi-Hsiou Daniel and Oomen, Roel C.A. and Stremme, Alexander, 2006, Do Sentiment Indicators Improve Dynamic Asset Allocation? via SSRN
Faber, Meb, 2007, A Quantitative Approach to Tactical Asset Allocation. The Journal of Wealth Management, via SSRN
Basak, Suleyman and Chabakauri, Georgy, 2009, Dynamic Mean-Variance Asset Allocation, via SSRN
Blitz, David and van Vliet, Pim, 2009, Dynamic Strategic Asset Allocation: Risk and Return Across Economic Regimes, via SSRN
Picerno, James, 2010, Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor, Book
Pedersen, Thomas Quistgaard, 2010, Return Predictability and Dynamic Asset Allocation, Thesis
Maillard, Didier, 2011, Dynamic Versus Static Asset Allocation: From Theory (Halfway) to Practice, vis SSRN
Yang, Zhaoji George and Zhong, Liang, 2012, Optimal Portfolio Strategy to Control Maximum Drawdown – The Case of Risk-Based Dynamic Asset Allocation, via SSRN
Butler, Adam and Philbrick, Mike and Gordillo, Rodrigo and Varadi, David, 2012, Adaptive Asset Allocation: A Primer, via SSRN
Wang, Peng, Rodney Sullivan, Yizhi Ge, 2012, Risk-Based Dynamic Asset Allocation with Extreme Tails and Correlations, via JPM
Cardinale, Mirko, Marco Navone and Andrzej Pioch, 2014, The Power of Dynamic Asset Allocation, via JPM
Almadi, Himanshu, David Rapach and Anil Suri, 2014, Return Predictability and Dynamic Asset Allocation: How Often Should Investors Rebalance? via JPM
Du Plessis, Johannes Paulus and Hallerbach, Winfried George, 2015, Volatility Weighting Applied to Momentum Strategies. Journal of Alternative Investments, via SSRN
Petre, Gabriel, 2015, A Case for Dynamic Asset Allocation for Long Term Investors. Procedia Economics and Finance. 29.
Keller, Wouter J. and Butler, Adam and Kipnis, Ilya, 2015, Momentum and Markowitz: A Golden Combination, via SSRN
Howe, Thomas S and Pope, Ralph, 2015, Long-Run Performance of Dynamic Asset Allocation Strategies, via SSRN
Madhogarhia Pawan and Marco Lam, 2015, Dynamic Asset Allocation, Journal of Asset Management
An, Byeong-Je, Andrew Ang, Pierre Collin-Dufresne, 2015, How Often Should You Take Tactical Asset Allocation Decisions? via FMA
Moreira, Alan and Muir, Tyler, 2016, Volatility-Managed Portfolios. Journal of Finance, Forthcoming, via SSRN
Grennon, Terence, 2016, A Dynamic Asset Allocation Approach to Investing, via SSRN
Hamill, Carl, Rattray, Sandy, Van Hemert, Otto, 2016, Trend Following: Equity and Bond Crisis Alpha, via SSRN
Dreyer, Anna and Hubrich, Stefan, 2017, Tail Risk Mitigation with Managed Volatility Strategies, via SSRN
van Zundert, Jeroen, 2017, Volatility-Adjusted Momentum, via SSRN
Harris, Richard D. F. and Stoja, Evarist and Tan, Linzhi, 2017, The Dynamic Black-Litterman Approach to Asset Allocation, via SSRN
Harvey, Campbell R. and Hoyle, Edward and Korgaonkar, Russell and Rattray, Sandy and Sargaison, Matthew and van Hemert, Otto, 2018, The Impact of Volatility Targeting, via SSRN
Harvey, Campbell R. and Hoyle, Edward and Rattray, Sandy and Sargaison, Matthew and Taylor, Dan and van Hemert, Otto, 2019, The Best of Strategies for the Worst of Times: Can Portfolios be Crisis Proofed? via SSRN
Rattray, Sandy, Granger, Nicolas, Harvey, Campbell, Van Hemert, Otto 2019, Strategic Rebalancing, via SSRN
Karris, Michael, 2019, Alpha, Beta and the Endowment Model, via SSRN
Raymond, Micaletti, 2020, Towards a Better Fed Model, via SSRN
Clark, Joseph and Swan, Robert, 2020, Dynamic Asset Allocation With Options, via SSRN
I’d then add:
For momentum and trend:
https://awealthofcommonsense.com/2019/06/will-trend-following-continue-to-disappoint/
https://theirrelevantinvestor.com/2019/02/08/miss-the-worst-days-miss-the-best-days/
https://www.philosophicaleconomics.com/2016/01/movingaverage/
https://seekingalpha.com/article/1824492-a-simple-and-timeless-way-to-trade-the-s-and-p-500-successfully
For momentum and leverage:
http://www.ddnum.com/articles/leveragedETFs.php
https://seekingalpha.com/article/4625213-combined-leveraged-and-non-leveraged-etfs-tactical-allocation
https://seekingalpha.com/article/4625119-tqqq-not-for-the-faint-of-heart
https://www.reddit.com/r/LETFs/comments/mdb4n4/backtesting_tqqqs_hypothetical_performance_over/
For some IRL amateur DIY momentum systems with leverage:
https://dualmomentumsystems.com/
https://www.optimizedportfolio.com/hedgefundie-adventure/
For some deep dives:
https://www.dimensional.com/us-en/insights/myth-busting-with-momentum-how-to-pursue-the-premium
https://www.robeco.com/us/insights/2021/09/momentum-is-a-self-fulfilling-prophecy-and-therein-lies-its-strength.html
https://www.linkedin.com/pulse/momentum-markowitz-golden-combination-paper-review-abdennour-aissaoui?trk=pulse-article_more-articles_related-content-card
https://blog.validea.com/the-core-principles-of-momentum-investing/
For very long / multi-regime backtests:
https://dualmomentum.net/2018/10/16/extended-backtest-of-global-equities-momentum/
https://alphaarchitect.com/2018/04/the-worlds-longest-multi-asset-momentum-investing-backtest/
For momentum and value:
https://blog.validea.com/four-ways-value-investors-can-use-momentum/
https://insights.finominal.com/research-low-vol-momentum-vs-value-momentum-portfolios/
For accelerating momentum:
https://allocatesmartly.com/taa-strategy-accelerating-dual-momentum/
https://engineeredportfolio.com/2018/05/02/accelerating-dual-momentum-investing/
https://allocatesmartly.com/accelerating-dual-momentum-redux-longer-history-tempered-expectations/
For improving momentum:
https://insights.finominal.com/research-improving-the-momentum-factor/
For when to avoid momentum:
https://seekingalpha.com/article/4419893-when-to-avoid-momentum-investing
For NASDAQ momentum strategies:
https://seekingalpha.com/article/4413810-momentum-strategies-nasdaq-100-stocks
For different look back and hold periods:
https://seekingalpha.com/article/4514584-combining-long-short-term-momentum-strategies
@ TLI – that’s an extraordinary list! Thank you. I’ll have caught you up in about a decade 😉
My pleasure @TA 🙂
Honourable mentions are also due to both of Gary Antonacci’s:
– “Risk Premia Harvesting Through Dual Momentum”, Journal of Management & Entrepreneurship, vol.2, no.1 (Mar 2017), 27-55; and,
– “Absolute Momentum: A Simple Rule-Based Strategy and Universal Trend-Following Overlay” 4 Apr 2013, revised 13 Jun 2015
Both of which are on SSRN. Gary’s Dual Momentum strategy has not done well since 2015 and tbh such a generic strategy (long US stocks, or ex US stocks or US bonds based upon relative momentum with a 12 months’ lookback and 1 month review period) whilst, IMO, somewhat likely to modestly outperform the SP500 over long periods, is not going to really shoot the lights out. On the other hand, Gary’s book “Dual Momentum Investing” is really clear, and the backtest looks to be one of the most reliable out there.
A final shout out should probably also go to Wesley Gray Ph.D and Jack Vogel Ph.D for their book “Quantative Momentum” (2016), published by Wiley Financial Series.
You guys might be interested in this academic overview of momentum:
https://alphaarchitect.com/2023/10/momentum-research-summary/
Although ideally we’d be having this conversation over here 😉 :
https://monevator.com/momentum-premium/
Excellent meta resource overview @TI. Thank you.
What worries me most are costs, strategy capacity & the deadly duo of dubious data quality and data mining artifacts. The last two concerns are generic to investment performance studies, but are almost certainly a bigger issue for momentum. I faintly remember a paper on momentum showing that if you rebalanced at average market prices for the middle of first trading day in the month then your multi-year return was ‘x’, but if you traded at the closing price that same day then it was ‘y’, where x and y were two very different numbers indeed.
On trading costs / frictions, we’ve got Gary Antonacci saying that they preclude successful firm level momentum, but with Frazzini, Israel, and Moskowitz saying the opposite, and with Jack Vogel giving a nice summary of the position here:
https://alphaarchitect.com/wp-content/uploads/2021/08/Factor_Investing_and_Trading_Costs.pdf
And whilst Jack thinks that there’s perhaps $50bn capacity in US markets for firm level momentum (without it arbitraging away), others think it’s no more than $5bn (although I’m not aware of anyone yet saying that there’s any capacity constraint for index level momentum).
At the end of the day, momentum is active investment whichever way you cut it. If you do it, then you have to do so with eyes wide open, fully recognising that if combined with trend following then it’s just market timing, even if of the evidence and rules based variety.
It’s always worth asking oneself: do I actually need the possibility of extra returns; and do I accept the risks, stresses and hassles that go with that?
When thinking about those questions I find it helpful to reread both the fable of the US banker and the Mexican fisherman and then Tolstoy’s tale of the misguided peasant, Pahóm, in “How Much Land Does A Man Need?”, links to each below:
https://medium.com/the-concurrent-project/the-fisherman-and-the-banker-9e3b061075b6
https://www.online-literature.com/tolstoy/2738/
One of the problems with using metrics to evaluate and rank approaches – be they passive or active – is that, fundamentally, we can never be certain that they are reliably and consistently useful across long time periods and different market regimes.
This paper takes the rather unusual tack of seeing if the main metrics in common use, like the Sharpe and Sortino ratios, actually managed to correctly rank the relative performance, measured by total returns, of various perfect hindsight allocations from the 1934-1999: “Benchmarking Performance Measures With Perfect Foresight Asset Allocation Strategies” by Robert R Grauer at Simon Fraser University, Burnaby, British Columbia, published summer 2008. Spoiler alert – they failed miserably to do so.
A further very thought provoking piece of research (“The Surprising Alpha From Malkiel’s Monkey and Upside-Down Strategies”) by Research Affiliates:
https://www.researchaffiliates.com/publications/journal-papers/p_2013_aug_surprising_alpha#:~:text=Paradoxically%2C%20the%20upside%2Ddown%20strategies,information%20ratios%2C%20and%20CAPM%20alphas.
Summary: “contrary to popular wisdom, the investment beliefs on which many well-established strategies are based play little or no role in their outperformance vis-à-vis capitalization-weighted benchmarks. The authors reach this striking result by inverting the popular strategies’ weighting algorithms and find these inverted strategies produce equal or better outperformance. Interestingly, so does any random stock selection strategy, even a monkey throwing darts at the Wall Street Journal to select stocks”