When we started the Excess Returns podcast, our primary goal was to learn. We wanted to help listeners to the podcast learn. But we also wanted to learn ourselves. When we have selected guests to bring on, we have focused on guests we think have a lot to teach both us and our audience.
After each episode, I always like to create some bullet points for myself that cover the major lessons I learned. As I compile them over time, they serve to help me refine the way I think about investing and help to improve the process we use as we construct our own investment strategies.
When I was making this list after our recent episode with Dynamic Beta founder Andrew Beer, it struck me that it might be better to write about what I have learned publicly rather than just keep some of my own notes because it will force me to better explain the lessons and better understand them myself. And hopefully some others can benefit from them as well.
Here are my three biggest lessons from our interview with Andrew Beer.
[1] Think Outside the Box
We all tend to get set in our ways in our portfolios. We have our stocks. And we have our bonds. We might do some smaller stuff on the side, but for most investors those two asset classes form the core of their portfolios. And that worked fine for a very long time. But this year has shown us that there are benefits to being open to more creative approaches than that.
We specifically spoke with Andrew about managed futures. Managed futures is unique in that it is one of the very few things that has worked this year. Many managed futures strategies are up over 20 percent in 2022 and have provided an excellent hedge for those that coupled them with a standard stock and bond allocation.
As Andrew pointed out in the interview, the empirical case for adding managed futures to a stock and bond portfolio is exceptionally strong. But very few investors do it. Which gets me to my next lesson.
[2] Behavior Can Be the Enemy of the Optimal Portfolio
One of the reason many investors don’t employ strategies like managed futures is rooted in our behavior. It is difficult to lose money in the market and all of us tend to make behavioral mistakes when we are doing it. But in my experience, it is even more difficult to underperform our neighbors. There is nothing worse than seeing other people make money when we are not. This can lead us to abandon strategies that have very different return profiles than traditional ones at exactly the wrong time.
Managed futures is a great example of that. Managed futures strategies have two key attributes that can benefit investors. First, they have little or no correlation with stock and bond returns. Second, they tend to produce positive returns most of the time. That sounds great, right?
The problem comes during long bull market runs like the one we just finished. When stocks and bonds are both producing above average returns, managed futures strategies are likely to trail them. For investors who incorporate them into their portfolios, this introduces what is called line-item risk. If I look at the components of my portfolio after a long market run, I will likely see managed futures trailing. That leads me to question why I have it in the first place. And usually right when I have had enough and abandon the strategy, we get a year like this one where it shows why it was there in the first place. So utilizing strategies like this that are different requires looking at a portfolio in an overall context and not evaluating each holding in each period. It also requires being willing to look different than our neighbors.
[3] The Cigar Butts Might be Gone for Good
As a value investor, I try to seek out opinions that contradict my own as often as I can. I may believe that value still works and is attractively priced now, but that conviction can sometimes prevent me from seeking out and giving credence to the other side of that argument. To combat this, I try to seek out well informed views that take the other side.
Andrew offered one of the best answers we have had as to why value might not work as well in the future as it has in the past. I won’t try to explain the whole thing here because I won’t do it justice, but you can listen the 1:01:45 mark in the video below to hear him explain it.
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Originally Posted October 26, 2022 – Three Lessons From Andrew Beer
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