Does Experience Provide an Asset Class Trading Edge?

Does experience trading the markets provide an actual trading edge? Surely an investor who’s seen many bull and bear markets has an advantage compared to a novice just starting out in the field. The beginner is an alpha source for seasoned traders as the former pays their “tuition” associated with learning how to trade. The counterargument, using efficient markets logic, suggests that if a great number of portfolio managers (PMs) have significant experience, then the performance benefits of experience become arbitraged away as prices quickly incorporate the collective wisdom of the pros and experts.

Fund marketers ignore the efficient markets logic and advertise portfolio manager experience because it’s very convincing to most customers. I’ve traded asset classes for about 20 years. I’ve experienced two major and several minor bear markets, and seen a variety of bull markets. When I assess my current trading edges, I admit I’ve started putting “experience” as an edge – although at times with a question mark behind it.

Studies show that manager tenure and experience has little impact on mutual fund performance.1 I’ll speculate that the constraints associated with mutual fund portfolio management greatly inhibit the use of experience as an edge. Prospectus limitations on what securities can be purchased and the requirement to stick with an established investment discipline limit the flexibility to use experience to add value. Career risk can also drastically alter a PM’s personal risk-return profile, inhibiting the use of experience to benefit clients.

Seasoned relationship managers and investment advisors can be highly valuable to their clients since they draw on experience to help a client weigh the pros and cons of making a decision – especially in stressful moments. Of course, their job is not about adding alpha, although many claim they can. Just because a person has 20 to 30 years in the industry doesn’t mean they automatically have an “experience edge” that translates into superior performance. Many PMs are not intentional in how they learn from their experience. They’re lazy.

As an asset class trader, free to shift to any asset class and any investment style at any time, experience can become an impactful trading edge. Intentionally developing an “experience trading edge” requires a carefully planned personal mastery process. Much like a training program used by elite athletes, this mastery process is used to successfully play the asset class trading “meta-game” to better assess what approach works best at a particular moment in time. The mastery process is never-ending and consists of learning, practicing, recording results, reflecting and incorporating feedback to get better. To ignore the process is a huge missed opportunity to get better at this game, and perhaps develop an “experience” trading edge. (more…)

Don’t Bet on the Active Manager Revival

The massive migration of assets from actively managed equity funds to index funds has attracted a lot of attention lately.1-6 The discussion varies, including worries about the future of active managers, concerns about market efficiency, and claims that active managers are about to outperform, and a variety of social impacts caused by this trend.

The flow of assets among U.S. equities is massive and may be a sea-change inflection point in the financial markets. The transition toward indexing has accelerated in the U.S. as more and more professional investment advisors have finally acknowledged the failure of active management. New Department of Labor fiduciary rules also make it more difficult for investment advisors to recommend active managers without exposing themselves to potential litigation risk. Figure 1 from a recent Wall Street Journal article, using data from Morningstar, shows the accelerating trend.1 Similar trends are occurring more slowly among bond funds and international equity funds.

Figure 1.

Many articles, mostly wishful thinking from those selling active stock picking, suggest the “performance pendulum” will eventually swing back in favor of active managers outperforming. John Rogers, a highly respected portfolio manager for the Ariel Funds, recently captured active stock pickers’ common sentiment about active versus passive management.

“This is going to be the decade for stock pickers. … It’s been a long trend we’ve gone through where active managers have underperformed. We know in 30 years of doing this … we have gone through these waves. Things become very popular, very hot and everyone follows that concept. What’s worked yesterday gets everyone excited and people give up on what’s not working and often that’s where the opportunities are.” 6

Barron’s seems to be hot on this idea, with multiple articles suggesting active stock picking will make a comeback.7,8 Perhaps they’re nostalgic for the investing world of the 1980s and 1990s when stock pickers were the investment stars.

A much talked about research piece out of Sanford Bernstein, titled “The Silent Road to Serfdom: Why Passive Investing is Worse Than Marxism”, lamented a world where indexing dominated the markets.4 Figure 2 shows the parabolic rise in the number of indices used to track various slices of the markets. (more…)

Top 10 Thought Leaders for Asset Class Traders

iStock_000077319945_XSmallThe beginning of the year marks the time when chief investment officers, market strategists and other chief prognosticators publish their top investment themes. Barron’s also publishes their much anticipated “round table” issues in mid to late January, which pull together top investors to discuss the state of the markets and where they see investment opportunities.

There are hundreds of firms producing research all the time, most of it free. The big Wall Street firms produce enormous amounts of content, but so do practically all buy-side investment management firms these days. If you’re not careful, combing through research reports for trading and investment ideas can absorb all of the day. There are also the independent firms such as Ned Davis Research, BCA Research and the Leuthold Group, which are very expensive, but provide lots of interesting and useful information for asset class traders.

Common sense suggests that you can’t just read the research, implement the trades suggested and expect to outperform the market. That would be too easy. This is the case even for costly research from the independents, because after all, tens of thousands of professional portfolio managers can afford these services.

For an asset class trader, reading research and market commentary is important, primarily so you understand what everyone else is thinking, become aware of crowded trades and estimate what information is already priced into the markets. Every once in a while, a new piece of information is gleaned or a new way of thinking about an asset class is found. If discovered ahead of most other market participants, this information can be the seed of a new trade.

Thought Leaders

At any point in time, there are industry thought leaders who seem to have a special knack for investing and trading the markets. When they speak, I pay careful attention because the probability of discovering a new trade idea from them is much higher than reading the everyday, run-of-the-mill content.

Generally, these thought leaders are very experienced, talented and rich. They’re not inhibited by career risk. Their motivations are aligned with us, because being right about an investment theme is the most important goal associated with speaking publically since the prediction is on the record. Contrast this motivation with that of research content providers and newsletter writers, where maximizing readership is the primary goal. (more…)

Asset Class or Trading Strategy? 

Liquid alternative funds are the new hip product sold by investment management companies. Liquid alt funds offer strategies that have been used by hedge funds, managed futures funds and private partnerships for many years with the potential to earn a higher risk-adjusted return than stocks and bonds often combined with a low correlation. Previously this space was largely off limits to small investors due to institutional-sized minimums or the need to be an accredited investor. Now these strategies are accessible to all investors via ETF and open-ended fund structures, which offer daily liquidity.

The trend towards liquid alt funds is motivated by the desire for enhanced portfolio diversification and the need to do something about low bond yields. These were the same motivations that led to the massive growth of hedge fund assets over the past 10 years as pension funds allocated to this space following the 2000 to 2002 bear market.
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