Category: Investing Insight

Investing insight to make you a better investor.

Individual Investors and the Market Timing Myth

Quantitative Analysis of Investor Behavior

There’s an annual report, called the Quantitative Analysis of Investor Behavior, produced by the DALBAR organization, that tracks the behavior of individual investors. Here’s their key finding:

Over the past 20 years, “equity fund” investors achieved an average 5.02% annualized return, which is 4.2% less than the 9.22% that he/she could have achieved by simply investing funds in an S&P500 index-tracking fund.

Although the report covers only retail investors in the US, its findings hold a mirror to investor behavior in general.

Investor education doesn’t help

Louis S. Harvey, President of DALBAR, argues that: “It is now past the time for the investment community and its regulators to understand that the principle of educating uninterested investors about the complexities of investing is unproductive.”

No matter whether the market is booming or busting, “Investor results are more dependent on investor behavior than on fund performance.” Investors who buy and hang on are consistently more successful than those who move in and out of the markets.

The report concludes:

“Attempts to correct irrational investor behavior through education have proved to be futile. The belief that investors will make prudent decisions after education and disclosure has been totally discredited. Instead of teaching, financial professionals should look to implement practices that influence the investor’s focus and expectations in ways that lead to more prudent investment decisions.”

Are our policy makers, SEBI included, taking notes?

Source: financial-math.org

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93 Technical Indicators that don’t Predict Market Returns

There’s a research paper out that looks at 93 common technical indicators and concludes that they have no predictive power whatsoever:

We review the predictability of a wide range of 93 technical market indicators in predicting the S&P 500 returns. This adds to the literature with evidence from widely used but less examined market indicators, to more conclusively answer the question of whether technical analysis is useful or not. Overall, we do not find the market indicators generate profits that beat the buy and hold strategy. This result does not change if we consider the possibility of regime-switching predictability on business cycles or sentiment cycles. Moreover, our results remain robust if we use a GARCH (1,1) or robust regression method.

Source: Technical Market Indicators: An Overview

Related: Technical Analysis

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Refracting Fund Portfolios: PPFAS

  1. Where does alpha come from?
  2. How much should you pay for alpha?
  3. If a fund manager claims that his portfolio is a “long-term” bet, then does it make sense to just buy all the stocks in his portfolio rather than pay him an asset management fee for the privilege?
  4. How much do “other” investments add to returns?
  5. Will an equally weighted portfolio out-perform a hand-crafted weighting?

To answer these questions, we have started an experiment. We have created an equally weighted portfolio of NSE listed stocks in the PPFAS Long Term Value Fund (Factsheet.) The Theme will be re-balanced once a month, as soon as the PPFAS portfolio disclosure becomes public. As of the latest information available, 72% of the fund’s portfolio was invested in Indian equities & 21% is invested in foreign equities with the balance amount in Cash Equivalents.

Over a period of time, we hope to answer the questions we have raised above.

You can follow the Theme here: Refract: PPFAS Long Term Value Fund

Refract: (of water, air, or glass) make (a ray of light) change direction when it enters at an angle. From Latin refract- ‘broken up’, from the verb refringere, from re- ‘back’ + frangere ‘to break’.

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You are always right in some universe

In recent years a number of investigators have developed the view that those supposedly irrational choices that people make merely reflect the fact that their brains are guided by the mathematical principles of quantum physics.
 
Quantum cognition has proved to be able to account for puzzling behavioral phenomena that are found in studies of a variety of human judgments and decisions.
 
Human judgments “are often not simply read out from memory, but rather, they are constructed from the cognitive state for the question at hand.” Consequently drawing a conclusion about one question alters the context, disturbing the cognitive system just as a quantum measurement disturbs an electron. Such disturbances will influence the answer to the next question, so that “human judgments do not always obey the commutative rule of Boolean logic.”

Source: Quantum math makes human irrationality more sensible

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Doing Nothing: Bubble Edition

Aswath Damodaran, a Professor of Finance at the Stern School of Business at New York University, has an interesting post on market bubbles. Is it worth the time and effort to spot bubbles? What are you supposed to do if you have strong feelings about the existence of a bubble? I’ll just list his key takeaways here, you should read the whole thing at your leisure.

  1. There will always be bubbles. Bubbles are part and parcel of financial markets, because investors are human.
  2. But bubbles are not as common as we think they are. And they are not always irrational.
  3. Bubbles always look obvious in hindsight.
  4. Bubbles are not all bad.
  5. Doing nothing is often the best response to a bubble.

Source: Bubble, Bubble, Toil and Trouble: The Costs and Benefits of Market Timing

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