Insights|Nov 05, 2020

Pointing Out the Straw Person

Artificial Intelligence
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The Straw Person Argument

A straw person argument distorts an opposing stance to make it easier to attack. The person using the straw person attacks a distorted version of their opponent’s stance (which is the straw person), which their opponent does not actually support.

Pointing Out the Straw Person

Our Global Tactical Asset Allocation (GTAA) strategy uses extensive data analysis and machine learning to tactically shift portfolio allocations between countries, stocks, REITs, high yield bonds, investment grade bonds and US Treasuries to participate in rising markets and avoid large losses during bear markets.

We have often found ourselves in the position of having to defend the GTAA strategy against a straw person. On several occasions, it has been falsely labelled as a market timing strategy. This accusation is then followed by a declaration that nobody can successfully time markets, and that any strategy predicated on this impossible task is therefore doomed to fail.

Market timing is a distinct strategy which involves predicting the future. Market-timers attempt to forecast turning points in markets before they occur to invest at market bottoms and sell (or go short) at tops.

By contrast, our GTAA mandate is built on a data-based, AI-driven approach to trend following. Unlike prediction-focused market timing, trend following is reactionary in nature. Rather than predict the future, our GTAA strategy uses quantitatively driven signals to determine the current (rather than future) market environment and adjusts its portfolio accordingly.

When our models indicate a favourable market environment, they reap gains by shifting into pro-cyclical, higher risk assets such as equities and high yield bonds. Conversely, when they signal an inhospitable situation, they avoid large losses by shifting into safe-haven assets such as short-term investment grade corporate bonds and U.S. Treasuries. This approach enabled our GTAA strategy to protect clients from large losses during times of turmoil and achieve superior performance on a risk-adjusted basis.

Practical Considerations

Attempting to predict precise turning points in markets – sell at highs and buy at lows – is an exercise in futility. We do not know of any manager that has accomplished this feat with consistency.

The reactionary nature of trend following means that, by definition, trend followers will only buy after a bottom has formed and will only sell after markets have started declining. In other words, we will always be late. Our GTAA strategy will only move to the sidelines after markets have started to decline at the beginning of a bear market. Similarly, we will miss the proverbial first hour of the party during the initial move higher at the beginning of a bull market. The objective of our AI-based methodology is to participate in the majority of the upside in a bull market while avoiding the majority of losses in a bear market.

The Devil is in the Details – Our DNA

Determining whether the investment environment is favourable or hostile is no easy task. As such, how one goes about making this determination is of utmost importance. At Outcome Metric Asset Management, one of our mottos is “In God we trust. All other bring data.”

Our investment strategies are based exclusively on data analysis and machine learning. We don’t do things based on our opinions. If we do, it’s based on opinions about mathematical phenomena and statistical distributions, not forecasts about Fed policy, interest rates, inflation, unemployment, or economic growth. This basic philosophy defines our approach to investing and is deeply embedded in both our GTAA as well as our Enhanced Dividend funds.

John Henry, the founder of investment firm John W. Henry & Company and owner of the Boston Red Sox, was an earlier adopter of a purely data-driven, mechanical approach to investing which precludes any subjective evaluation of markets. Our beliefs are well summarized by Henry, who stated:

“I will never have a complete or full understanding of anything. Therefore, all investment decisions should be based on what can be measured rather than what might be predicted or felt.”

“People in both fields [stock market and baseball] operate with beliefs and biases. To the extent that you can eliminate both and replace them with data, you gain a clear advantage.”

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