The Irrelevant Investor

Strategies Can Beat The Market, You Cant

Finding a strategy that can beat the market over a reasonable period of time is relatively easy. Its sticking to it that is the challenge.

Consider a simple strategy that Ben Graham first tested in the 1970s; a thirty-holding portfolio of stocks with a price-to-earnings ratio under 10 and a debt-to-equity ratio below 50 percent. Here are the rules: you sell a stock when they return fifty percent, and if they hadnt returned fifty percent after two years from the purchase date, you sell it regardless of the price.

Wesley Gray, PHD and Tobias Carlisle recreated this study in their excellent book, Quantitative Value . From 1976-2011, this portfolio compounded at 17.8% per year while the S&P 500 TR compounded at 11.05% per year. This simple strategy beat the market 90.35% of rolling 5-year periods and 95.53% over rolling 10-year periods. However, this out-performance did come with a cost, significantly higher volatility and market like draw downs. On any given month, this proven strategy had a forty percent chance of losing money. Furthermore, during one single month this strategy lost almost twenty-nine percent.

These draw downs are what have people chasing unicorns and adding unnecessary complexity to their investment strategies. If youre searching for market-like returns without the possibility of principle risk, Dr. Gray has some sobering news for you.

The sad conclusion is that none of these ideas stand up to intense robustness tests, except for the simplest, technical rules. You just cant beat them. Its kind of crazy when you think about it. We had hoped that having tested every model and approach under the sun that we would be able to triumphantly announce that we had identified a way to reliably predict the market using fancy algorithms derived from 100s of academic researchers. But it just wasnt the case. Weve built these models: They arent reliable; they arent robust; and they are littered with data-mining. A large swath of the financial services industry would love to have you believe in their magic. Im here to tell you that it doesnt exist. Sorry.

You can lead an investor to a winning strategy, but you cant make them stick with it when the going gets tough. Unfortunately, success comes at a steep price. You need to be willing to sit through periods of downright dreadful performance. No risk, no reward. It really is that simple.