Investing presents an interesting paradox: the approaches that are most effective in attracting capital and clients often prove to be the least successful in generating optimal long-term outcomes. Common practices such as chasing recent strong performance, investing in popular stocks, and believing that successful investing must be complex may look appealing, but they rarely lead to the best long-term results.
This article explores some unconventional investing strategies that, while unlikely to be used in marketing, could potentially lead to superior long-term performance for investors.
1. Investing in Strategies with Poor Recent Performance
While it may seem counterintuitive, investing in strategies that have underperformed in recent years can be better than ones that have outperformed. Here’s why:
- Behavioral biases play a significant role in reducing investor returns over time. The “behavior gap” (investors making poor timing decisions) can decrease returns by an estimated 120 basis points or more, which is higher than the typical fee difference between active and passive funds.
- Investors tend to flock to strategies with great recent performance and abandon those with poor performance, often to their detriment.
- Three-year returns, commonly used to evaluate strategies, are actually one of the worst timeframes for selection. This is because strategies typically go out of favor for a similar time frame before turning around.
History shows that extended periods of underperformance are often the best times to invest in a strategy with a good long-term record.
2. Owning Unpopular Stocks
To truly capture the value premium over time, investors need to own a basket of stocks that are currently out of favor and have bleak future prospects in the eyes of most market participants. This approach works because:
- Investors tend to overreact to bad news, creating opportunities in unpopular stocks.
- The market often prices in overly pessimistic assumptions for these companies.
- While these stocks may not have exciting stories, they can offer great value for patient, long-term investors.
Deep value portfolios typically contain stocks that few investors are excited about, but this contrarian approach can lead to superior returns over time.
3. Employing Simple Investment Strategies
There’s a common misconception that successful investing, particularly quantitative investing, must be complex. However, simplicity often trumps complexity in investment strategies:
- Simple strategies based on fundamental metrics like earnings, sales, or enterprise value can perform well over time if consistently applied.
- Basic approaches, such as those outlined in “The Little Book That Beats the Market” by Joel Greenblatt, have produced significant market outperformance using just two criteria: earnings yield and return on capital.
- Simple models are easier to understand, which can help investors stick with them during inevitable periods of underperformance.
While these unconventional approaches are unlikely to be used in investment marketing anytime soon, they highlight an important truth: what attracts investors to a strategy is often at odds with what produces the best long-term results. As evidence-based investing gains prominence, there may be a shift towards these more counterintuitive but potentially more effective strategies.
In the meantime, investors might benefit from considering simple investment strategies with strong long-term records that are currently out of favor and hold unpopular stocks. While not glamorous, such approaches could lead to superior long-term performance.
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