Commentary | Mar 05, 2020

Escalator Up. Elevator Down.

share

Saying that February was a challenging month in the markets would be a gross understatement, with global equities plummeting 7.6%. From its peak on February 19 through the end of the month, the MSCI All Country World Index plummeted 11.6%, a decline of unprecedented velocity.

In February, our GTAA strategy fell 2.9%. At the end of January, our GTAA model was receiving cautionary signals in several markets. As a result, we reduced risk. We liquidated our 10% positions in Eurozone, Japanese, and emerging market equities. This reduction mitigated losses by approximately 2% during February’s deluge.

As we tell both existing and prospective clients, our GTAA strategy will always be late. We will never get completely out of the market at the exact top, nor will we be 100% invested at the exact bottom. Rather, our objective is to avoid the majority of bear market losses while participating in the majority of bull market gains. This dual mandate can dramatically improve investors’ compounding rates and lead to significantly greater wealth over the long-term (not to mention fewer heart palpitations).

In February, our Enhanced Dividend fund declined 5.2%, outperforming the TSX Composite index by 0.7%, and outperforming the TSX Dividend Aristocrats Index by 1.1%.

If Markets are Inefficient, Why Do Most Managers Underperform?

We do not believe that markets are completely efficient, nor do we think that investors are what economists refer to as “rational utility maximizers”. Rather, we believe that cognitive biases and emotions can result in suboptimal investment decisions which lead to mispricing. This mispricing can be exploited to achieve superior long-term results.

But wait! If markets are inefficient, why do the vast majority of active managers underperform their benchmarks? According to the latest S&P Index vs. Active (SPIVA) Canada Scorecard, over 88% of Canadian managers focused on domestic stocks have underperformed the TSX Composite Index over the past 10 years – and that’s the good news! An astounding of 98.2% of U.S.-focused managers have underperformed the S&P 500 Index.

FOMO (Fear of Missing Out)

Just because most professional investors underperform doesn’t mean that markets are efficient. Investment managers may be unwilling to take advantage of mispricing opportunities, even if doing so can result in outperformance over the long-term, because they are hamstrung by perverse incentives.

In July of 2007, shortly before the financial crisis, Chuck Prince, then CEO of Citigroup, stated “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Months later, the bank was on the verge of collapse and he found himself out of a job.

Nearly thirteen years later, Mr. Prince’s comment has come to symbolize an attitude towards risk that led to the global financial crisis. In an environment that rewards risk, people suffer from FOMO (fear of missing out), which can lead to suboptimal behavior and subsequent disaster. During the good times, few people want to be the lemming that stops to say, “I don’t want to dance off the cliff”. It is this collective mindset that often lies at the heart of busts in financial markets, when FOMO turns to fear.

Daring to Be Different

Our Outcome strategies were designed with a different mindset. We believe that investing is largely about risk management, regardless of whatever economic environment or investment fad is driving markets at any point in time. We rely on data analysis, machine learning and pattern recognition to quantify and manage risk. We believe that this focus will enable us to continue delivering superior risk-adjusted returns over the long-term.