Basic ideologies of active management and alpha generation

There is a lot of talk these days about passive vs. active management and efficient market theory.  The evidence for passive indexing with its low costs coupled with the Fed’s monetary policy certainly has worked for investors over the last decade.  For most investors who have a 20 to 30 year time frame, willing to dollar cost average and do not have the time, being a passive investor across multiple asset classes will work just fine.  But can investors who take an active approach really outperform the S&P 500 over a market cycle?  In our opinion, it can be done both on an absolute and risk-adjusted basis by a considerably wide margin.

Many of you who have been reading our S&P 500 research for the last 6 years know that we are formulating our investment methodology and process around 20 plus years of research.

Today we wanted to go over our basic investing psychology, not the process of how we view the world of active management to outperform the market.

  • Historically, since markets have been trading, they have an upwardly bias factor, caused from human behavioral factors. 
  • Investors rarely want to move to 100% cash, unless there is potential for at least a 10% draw-down.  Most investors are subject to “Overreaction Bias”, causing whipsaw movements.
  • Market cycles can be traded over their life based upon their phase. (Sector Rotation)
  • Technical Analysis alone cannot forecast mean reversion or future price moves. 
  • Looking at the same data points; fundamentally, economically and technically will NEVER give you an edge over any other investors.  It only creates a binary event.
  • Position Sizing is vital to performance.  Equal weight in our opinion – not for the asset class level.
  • One strategy will not work in all environments, investors need to realize they have to be flexible.
  • Price is truth and fundamental multiples are not leading indicators of future price.
  • The market is smarter and more efficient than the best traders. The market is more efficient than ever before and will continue to become more efficient as quant’s develop better systems. 
  • There will always be dislocations and anomalies that will create out-sized returns.
  • Lastly, mitigating downside volatility is the only way to out-perform the index.  However, rarely do investors need to try and call tops to apply risk mitigation.  
Below we listed the last 13 months of our S&P 500 trades that generated excess market returns. Below are our 5 S&P 500 trades since August 2015. Since August 1, 2015 to Sept 23, 2016 the S&P 500 is up 3.18%. Comparatively, our 5 long only S&P 500 calls are up 21.07% over the same period.  The bottom-line is you don’t need to over trade, only put capital to work if you have a catalyst or the highest level of conviction.