The Performance Chase

December 22, 2015

Sound advice from James Osborne:

Your strategy is not going to work unless you work with it. I have beaten this dead horse well into the ground, but if you keep looking at your neighbor’s returns, you’re committing investor suicide. Somebody, somewhere did better than you this year. Lots of somebodies. Anyone who works for Facebook or Amazon or Netflix and has a bunch of their net worth in company stock probably crushed you this year. Is that a strategy you should pursue? Probably not, but you need to remind yourself why you have the strategy you do. Everything has a bad year. Value stocks get cheaper. Trendfollowers get whipsawed. S&P; 500 investors get caught in tech bubbles. “Factors” don’t show up.

You will either get this or you won’t. If you think you are entitled to the best return of the best strategy every year, good luck to you. You will bounce from strategy to strategy, constantly disappointed with your returns. You will chase performance and fail to capture the long term return of ANY strategy, let alone the “best” strategy. You’ll fire dozens of financial advisors and complain to your friends about what schmucks these clowns are. You’ll say the markets are rigged. For you, they are and always will be.

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In Search of Sustained Success

December 22, 2015

How do you rate an NBA team across a decade of play? One method is “Elo,” a simple measure of strength calculated by game-by-game results (Source: Nate Silver’s FiveThirtyEight). A description of Elo is below:

Elo ratings have a simple formula; the only inputs are the final score of each game, and where and when it was played. Teams always gain Elo points for winning. But they get more credit for upset victories and for winning by larger margins. Elo ratings are zero-sum, however. When the Houston Rockets gained 49 Elo points by winning the final three games of their Western Conference semifinal during this year’s playoffs, that meant the Los Angeles Clippers lost 49 Elo points.

A rating of 1500 is approximately average, although the league average can be slightly higher or lower depending on how recently the league has expanded. (Expansion teams begin with a 1300 rating.)

As Nate Silver recently tweeted: “Last time the Spurs were a below-average team was in Jan. 1998, right about when the Lewinsky scandal was breaking.”

spurs

Impressive, is it not? Talk about an organization that figured out a formula for sustained success. On the opposite end of the spectrum, consider the Elo of the Clippers as shown below:

clippers

Yes, they have become an above average team in recent years, but man did they stink for the better part of the last several decades!

What stands out to me in flipping through the Elo of the different NBA teams is the outliers. Yes, there are a lot of teams that hover around average, but there are some stark standouts.

How true this is in the financial markets as well. In fact, this reminded me of a study completed by BlackStar Funds a couple years ago when they looked at the lifetime total returns of individual stocks relative to the corresponding return for the Russell 3000. Again, what stands out to me is the outliers. 6.1% of all stocks outperformed the Russell 300 by at least 500% during their lifetime. Likewise, 3.9% of all stocks lagged the Russell 3000 by at least 500%.

BlackStar

Outliers are what makes this business fun and ultimately where the most money can be made. Just like with certain NBA franchises, there are multi-year winners and multi-year losers in the financial markets. Relative strength, much like Elo, can help you stay on the right side of those trends.

The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.

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Relative Strength Spread

December 22, 2015

The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards. As of 12/21/15:

spread 12.22.15

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

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