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Alpha Theory Blog - News and Insights

December 01, 2017

Concentration During Periods of High Volatility

As we’ve gotten feedback about the Concentration Manifesto, one common question is, “would the Monte Carlo simulation hold during periods of market turbulence?” To stress test the conclusion, we chose two periods of high volatility. The 12 months between June 2008 and June 2009 (high positive and negative volatility) and the 12 months ended February 2009 (the months leading up to market nadir).

While the results showed lower overall alpha returns for both portfolios during the financial crisis, the concentrated portfolio still outperforms and is safer than the diversified portfolio. This is due to maintaining the improved batting average during those periods.

 

June 2008 to June 2009

CM Blog

We reran this analysis for the 12 months leading up to 2/28/2009 and the relationship still holds. The difference in timeframes mainly impacts the alpha return for the two portfolios. Again, the separation between the portfolios is driven by the batting average difference between the concentration and diversified portfolios. 

 

Trailing Twelve Months Ending February 2009

CM Blog2

It’s worth noting that since we don’t have data prior to 2011, the assumption is that the batting average between these two portfolios remains consistent over time.  We did look at batting averages for the timeframes we have in our database and it appears to be relatively consistent except for a dip in June 2015. Note that this batting average includes all portfolios and is on an alpha basis, but does not assume fees. The goal was to look for some consistency over time.

CM Blog3

 

The Concentration Manifesto has become a part of the conversation about how to improve active management. Please keep the feedback and questions coming.

 

November 10, 2017

Predictably Insightful: Recap of the Behavioral Alpha Conference

 

This is a picture of me and Dan Ariely, author of “Predictably Irrational” and five other great books on decision pitfalls we all fall into. Dan was the keynote speaker at Behavioral Alpha 2017 an event put on by our friends at Essentia Analytics and we were proud to help sponsor.

 

Behavioral Alpha

 

The day was packed with great speakers including:

- Dan Ariely: “Behavioral Finance in Practice” 

- Denise Shull talking about “Your Senses, Feelings & Emotions are the Ultimate Dataset”

- Clare Flynn Levy: "Applying Behavioral Finance to Your Own Investment Process" 

- Fireside Chat with Mark Baumgartner: “Why Asset Allocators Care About Behavioral Analysis” 

- Cameron Hight: “Mistakes Managers Make & How to Fix Them”

- Peer Idea Exchange: Paul Sonkin and Paul Johnson: “Pitching the Perfect Investment:

- Managing the Tensions Between Analysts and Managers” 

- Dave Winsborough: “How the Collective Personality of Your Team Affects Performance”

 

Here’s a quick recap of some of the takeaways:

Dave Winsborough discussed ways that we can build better teams by understanding the goal we’re trying to accomplish, the needed components to accomplish that goal, and measuring the team participants to make sure that the team has all of the necessary components. It’s a relatively straightforward idea that should be applicable to almost any team.

Denise Shull discussed ways we can become better in tune with our feelings and emotions with the idea of learning when and how to leverage those feelings. Learning how to identify our own emotions is a powerful first step towards being able to mute the negative emotions and take advantage of the positive (signals).

Much of the conference was on emotion and bias and how they cause us to make poor decisions. I completely agree, but that’s not my expertise. I spent much of my time talking the processes that help mitigate bias. This primarily involved making our assumptions and decision process explicit so that they can be judged and analyzed.

Dan Ariely gave several fascinating anecdotes like how casinos are the best at applying behavioral tools, how company internal satisfaction surveys have predictive power for stock performance, how Intuit is giving teams time and money to try bold new initiatives to help them get over the risk of projects that fail, a weight scale that doesn’t show your weight (but tracks it over time) is a much better way to lose weight than one that gives immediate feedback that is subject to good-habit-breaking volatility, and how people in the next to the lowest tax bracket are the ones most opposed to minimum wage hikes because it could push them into the lowest rung of society. His major takeaway was the bias and personality are tough to eliminate so you have to create habits, rules, and routinized behaviors that help us do the things we say we want to do (very Alpha Theory😉).

Clare Flynn-Levy showed how investors can make better decisions by capturing some basic information about themselves and their decisions. Taking the time to tie those data points together can help us better understand when we make good decisions and when we make poor decisions. By understanding these cues when they’re happening we can take advantage of the positive and avoid the negative.

Mark Baumgartner discussed his time at the Ford Foundation and Institute of Advanced Studies and some of the things he’s seen in the managers he evaluates. He said that about 10% of the managers he meets have some form of structured process around behavioral science, decision making, portfolio management, position sizing, etc. He believes that the primary value of a manager isn’t based on these processes, but he believes there is a lot of easy to pick up alpha form implementing process. He would like to see his managers embrace it more actively but says the industry moves glacially while the products that help improve the process are evolving very fast.

The room was full of managers and allocators. There was a self-selection bias, but the crowd truly embraced the concepts for how to be better using the behavioral science discussed during the day. In fact, the crowd asked amazing questions and one of my favorite parts of the day was from a member of the audience that was expanding on his thoughts about the difficulties of capturing alpha. He said the number of investors has increased from 5,000 to 1 million over 50 years. How do you reverse that trend when it is one of the highest paid professions, where you get to work with amazing people, research a broad range of interest, get to meet leaders in industry, academics, and government, and be exposed to an array of amazing ideas? If I’m ambitious and at the top of my class, why would I not pursue that profession.

Hmmmmm, maybe we can ask Dan Ariely if he has some creative way to change that behavior.