My earlier post about passive investing does bring up an interesting point. Even though investors are, by and large, buying decent funds, they’re not making much money. As a class, DALBAR’s QAIB has shown pretty conclusively that retail mutual fund investors underperform-and the onus should really be where it belongs-on investor behavior. It’s not active management that is the problem. As Morningstar shows, investors are making good fund choices, but their emotional asset allocation decisions are killing them. Owning an index fund, unfortunately, does not make you emotionally numb. Index fund investors may be just as likely to fall prey to behavioral issues as active fund investors. Finding winning strategies is clearly possible, but that’s not the whole story. Good investor behavior is probably the best ticket to better returns.
We see the same thing here as every other money management shop with a good long-term strategy: a decent percentage of clients bail out after a period of short-term underperformance. What really makes for good returns is good clients. Seth Klarman, the legendary hedge fund manager, said exactly that in a recent interview with Jason Zweig:
…ideal clients have two characteristics. One is that when we think we’ve had a good year, they will agree. It would be a terrible mismatch for us to think we had done well and for them to think we had done poorly. The other is that when we call to say there is an unprecedented opportunity set, we would like to know that they will at least consider adding capital rather than redeeming.
You can’t say it more clearly than that. Imagine how much money clients would make if 1) they understood a strategy well enough to know when it had performed well, when it had performed poorly, and why, and 2) they added money during periods when the strategy was temporarily out of favor.
Relative strength trend following is an excellent strategy that has historically afforded investors large excess returns, along with periodic episodes of underperformance (i.e., good entry points). The inherent volatility keeps most investors away so that returns do not appear to have been arbitraged away over time. Unless human nature changes, the relative strength return factor is likely to continue to work extremely well over time. Have we mentioned this before? Yes-but the reason we are mentioning it again is because relative strength has had a significant period of underperformance which may be in the process of ending. (Check out the short-term and long-term views here.)
