Can You Earn Superior Returns? by Kendall J. Anderson, CFA – Anderson Griggs Investments

Research

I recently dusted off the Moto Guzzi and took a little ride to Alpharetta, Georgia.   It was a perfect day for a motorcycle ride, at least for me.  It was 60 degrees, sunny, and the wind was to my back.  Covered from head to toe in full protective gear that my family calls the “power ranger suit,” I was neither cold nor hot. I was in a state of pure enjoyment.

As I neared Alpharetta the urge to keep heading west all the way to California was so strong I almost gave in, but I reminded myself I had an obligation to the CFA Societies of South Carolina, Georgia, and Alabama. Of course I did the right thing and stopped to fulfill my commitment.

As I neared Alpharetta the urge to keep heading west all the way to California was so strong I almost gave in, but I reminded myself I had an obligation to the CFA Societies of South Carolina, Georgia, and Alabama. Of course I did the right thing and stopped to fulfill my commitment.

[drizzle]As I had done in years past, I was attending the Southern Classic Research Challenge, the local edition of the CFA Institute’s Research Challenge.  It’s a competition between university-sponsored teams composed of both undergrad and graduate students from finance and MBA programs. The teams each research a designated publicly traded company, write up a research report on it which is scored, and then present their findings to a panel of judges. There are three different levels to the competition: Local, Regional, and Global. Teams progress through these three levels until a Champion is declared the ultimate winner of the Global competition.

This year, the Southern Classic had twelve participating teams.  Each team’s written report is scored prior to the presentations.  On the day of the Southern Classic, the teams present and defend their recommendation to buy, sell, or hold common shares of the designated company to a panel of experts.  Three teams with the highest combined score are named as finalists.  My job was to judge the finalists and pick the winning team.  Of course, I had some help. There were four other experts chosen to judge the finals.  I find that most experts have gained a large portion of their expertise by making mistakes.  It would be a big disappointment to the students if they were judged by a single expert who could easily make a bad decision unrelated to the presentation.  With multiple experts, a single judge’s mistake can be corrected by the others.  The good news is, when we tallied our scores, all of us had chosen the same team as the Champion.  This is one time I can say that great minds think alike!

I will be taking a little longer ride in April as I head to Chicago to judge the Regional Competition.  The Local Competition winners, from universities whose home bases are located in Canada, the US, Central and South America, will be competing for the title of Regional Champion.  The following day, the Global Competition finals will also be held in Chicago, so I plan on sticking around to join the celebration.

I enjoy attending these events.  The students are exceptional.  The majority are the top business or finance students in their class.   Without yet accumulating too much baggage of life, they are excited and optimistic about their future.  It is good for me to see the excitement in their presentations.  Their actions assure me that the future they envision has a higher probability of becoming reality than that of the nay-sayers calling for the doom of the following generations.

It is also a learning experience for me.  I find out what they are being taught about finance, business and the capital markets.  They are indeed experts of the quantitative requirements of good financial analysis.  However, this skill is just the minimum needed in a professional setting.  Great analysts and portfolio managers know that relying only on quantitative skills will never produce superior returns.   We mentioned the benefit of having multiple judges where the average score produces a more reliable outcome than a single judge.  Yet to produce superior portfolio returns, following the crowd, or relying on the average, will not do the job.

It is pretty easy for all of us to obtain average returns.  There are many index fund options that will produce the average return of an index minus a small amount for the fee paid to maintain the fund.  Even with the use of index funds, if you combine more than one, your results will be the average results of the combined portfolio.  If you are wrong on the amount invested in each index, happen to choose an index fund that produces negative returns, or make any other of the multiple mistakes possible when choosing any investment, it could result in poor returns.  This same problem occurs whether you use index funds or actively managed funds.  What we do know, from studies such as the Dalbar analysis, is that individual investors, with or without the help of a traditional financial advisor, have a very poor track record of earning and keeping even the average returns.

From experience we find that most of the shortfall is caused by human nature.  We react to our fear by selling low.  We react to our greed by buying high. We invest our money on the belief that certain individuals have discovered a new way to make us rich.  We invest our money on the belief that a finance or economics researcher who studied market history can use that knowledge to accurately predict the future.

While our reactions to fear, greed, and an unwarranted belief in gurus are up to each individual to address, we do what we can to help.  When it comes to fear and greed, we encourage you to think clearly, remind you that you will never lose all your money, and explain that if it was so easy to make huge returns in a short period of time, everyone would be rich and no one would ever have to work again.  When it comes to the belief that one individual has come up with a secret method to earn you a great rate of return, we can remind you that all Ponzi schemes began and prospered because of this belief.

When it comes to professional research we face a very difficult problem.  By default, we know that most of the research studies completed and published in respected journals have been tested once, twice, or more with multiple reviews by competent and qualified individuals.  The problem is not the quality of the research, but rather determining what research is capable of helping you reach your financial goals.

Although a few of you may enjoy sitting down in the evening and reading a twenty page academic research paper on investing, I would venture that the majority of you would rather have a tooth pulled.  However, you deserve to know that we do review many papers.  Some of these are good and some are not.  Good research, in my opinion, is research that will help minimize your mistakes and make you better off

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