The Wall Street Journal issue of June 28, 2014 carried an article titled, “Huge Returns at Low Risk? Not So Fast.” The premise focused on what is known as “back testing”, whereby an investment analyst runs a series of computer simulations to identify an optimal portfolio of stocks that would have produced the best returns with the least amount of volatility for an historical period. Characteristics of that portfolio are then “teased out.” In the article, the author points out that the featured, hypothetical high performing Presidential Political Party Portfolio stocks all have “… ticker symbols derived exclusively from letters in either the word ‘Republican’ (Rubicon Technology, or RBCN) or ‘Democrat’ (Caterpillar, or CAT).”
Now that should give you pause. This is an instance of correlation NOT representing causation. Selections made based upon the ticker symbol containing letters in a couple of words? I read the article with humor, the author’s intent. But, in the worst of cases, an investment sales professional might try to foist this type of scheme off on unaware investors as a viable investment strategy. Certainly there are many other equally suspect, but well-trafficked schemes (NFL indicator, investing and sunspots, etc.). It is easy to ignore the written warning on most sales literature: “Past returns are no guarantee of future results.”
Many of our newsletters and blogs have cited those factors that DO cause stock prices to rise, so there is no need to go there now.
A related concern that we have goes to proposals that investors receive from investment advisors, showing a recommended investment portfolio that has had superior returns for a past period (one year, three years, five years, etc.). This is an old trick, but one that works surprisingly well for the salesperson. I know this, because on occasion when I am being interviewed by a new prospective client, I will be shown what my competitor is suggesting. The problem with this approach is that it is quite easy to compile this great returning portfolio based upon past results! The investor should instead ask the advisor to show the composition of an actual portfolio that was recommended to a client with similar circumstances 5 years prior, and how those returns panned out.
Finally, look out for advisors that choose to exhibit comparative investment benchmarks (Dow Jones Industrial Average, and Russell 1000, as examples) on their performance reports that are inconsistent with the kinds of stocks that they actually put into portfolios. I saw an example of this just last week when evaluating an outside portfolio for a client, one that Sigma does not manage. Half of the stocks in the portfolio were small to mid-sized companies, but the manager was comparing performance to the large company index — the Standard and Poor’s 500 Stock Index. Apples to apples comparisons are a must for obvious reasons.
All questions or comments are welcomed.
Bob Bilkie, CFA