They just won’t be right for the long.
In the stock market’s unique way of beating up on braggarts and know-it-alls, the fastest way to turn market-beating methods into average results is to let the world know what you’ve got. In fact, a recent study that looked at academic research purporting to give investors an edge found that the mere act of publishing a research paper to announce the results to the world was enough to crush the advantage of the strategy.
And that’s writing for academic journals, it’s not basing a mutual fund, newsletter or any other investment product that might be selling its strategy as delivering a specific above-the-norm difference.
That’s why any investment strategies that purports to surpass market returns by a predictable amount should be labeled “the Stupid Investment of the Week.”
The problem with such claims is clearly pointed out in a recent research paper “ Does Academic Research Destroy Stock Return Predictability ,” written by David McLean, a visiting professor at MIT Sloan, and Jeffrey Pontiff of Boston College.
The professors looked at 66 different studies which basically plumbed the depths of 82 different market anomalies that were supposed to lead to predictable gains.
The academics weren’t trying to predict market returns, but instead were looking at theories like “low- priced stocks do better than high-price stocks,” or “stocks with strong six-month momentum will continue their strong results for another six months.”
But it gets worse.
After the paper has been published, it looks like people do start to trade on these and the average strategy declines by about 35%, so if a published paper says you can make X-percent returns on this strategy, after the paper has been published the return is 35% lower.
Once you take 35% off the top because everyone else is trying to do the same thing. The advantage is gone.
The drop-off is even greater when the strategy is concentrated in investment areas that are easier and less costly to trade in, such as big, brand-name stocks. The easier it is for people to emulate the strategy, the faster the edge disappears.
That doesn’t mean investors should not pick out strategies that they think work, but instead it means they need to give up on the idea that they’re getting some kind of predictable, maintainable edge.
Consider, for example, the “Dogs of the Dow” strategy, which involves buying the highest-yielding stocks that are part of the Dow Jones Industrial Average. It’s a strategy that a conservative investor can be comfortable with, but they can’t necessarily expect it to beat the market consistently; in the last six full calendar years, for example, a Dow Dogs strategy topped the Standard & Poor’s 500 index three years, and lagged behind it in three others.
That didn’t mean the strategy was taking investors to the poor house — it didn’t, and there are still believers in it today — but people using the method to gain an edge never really had an advantage.
“If you feel strongly about an investment style or method, that’s good, and that’s going to help you be successful with it,” McLean said, “but if you believe that a strategy is going to give you 2% better than the market — or if a newsletter or mutual fund tells you their strategy can deliver that all the time—it’s just not going to happen. The market is going to step in and work on that until the advantage is gone.”
Ultimately, there are plenty of investment practices that average investors can gravitate toward; from buy-and-hold to swing trading, tactical asset allocation to technical analysis, there’s no one right way to make money.
And if you have found one you can be comfortable and that gives you a return you can be comfortable with, stick to it.
But if you think the strategy gives you an edge on the market, shut up.
The minute you tell the market how smart you are, the market is coming to get you.
And the moment an average investor falls for that kind of sales pitch, they have stepped onto a road headed for disappointment.
Source: Chuck Jaffe, MarketWatch
The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
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