12+ WAYS TO BEAT THE BENCHMARKS
by Bob Simpson, Synchronicity Performance Consultants
1. CHOOSE THE RIGHT BENCHMARKS If you don’t know your opponent, it is very difficult to defeat him. Most advisors use indices, like the S&P 500 or TSX 60, as their benchmarks even when they hold 50 or 60% of the portfolio in bonds and cash. Development of the proper benchmarks is an important step in building your process to beat the benchmarks.
2. FOLLOW A PROVEN, RULES-BASED APPROACH The inability of investors and money managers to beat the benchmarks has been greatly exaggerated. Books, like What Works On Wall Street, cite numerous methodologies, both fundamental and technical that have positive long-term performance relative to their benchmarks. Studies show that although only about 30% of professional money managers consistently beat the benchmarks approximately 50% of stocks listed on major exchanges provide investors with better returns than their indices. Benchmark out performance cannot be achieved without a rules-based investment strategy that has a history of beating the benchmarks. Investment management is quickly transforming into a form of Moneyball, where quantitative analysis is taking over from traditional methods of analysis. Develop your rules-based strategies or adopt them and you will be surprised at how your investment performance will increase, client satisfaction will increase and your confidence will skyrocket.
3. MAKE RISK MANAGEMENT A PRIORITY The way to make money is not to lose money. If you lose 50% of your money, you need to recover psychologically to start making good decisions again but you also need to double your money to break even. To beat the benchmarks, you need to avoid major market meltdowns and large losses on individual positions. Diversification, through limiting exposure to stock sectors, such as banks, energy or metals and mining, can help minimize risk and set you up for strong long-term performance.
4. GET YOUR ASSET ALLOCATION RIGHT - GOOD TIME TO OWN AN ASSET CLASS, GOOD TIME TO BE CAUTIOUS OR GOOD TIME TO AVOID AN ASSET CLASS?
“Buy and Hold” is a methodology developed by the “Can’t Beat The Benchmark” enthusiasts. The theory is that if you can’t beat the benchmarks, why not join them. Buy the indices and minimize fees and the world will be a better place. There are a few problems with this approach: 91.5% of performance comes from asset allocation so if you pick the wrong index, you will suffer from poor performance. This is accentuated by investment performance since 2000, where S&P 500 investors have earned a return of slightly greater than 4% but with losses approaching or exceeding 50% twice over that period. Your ability to help clients avoid or minimize damage during market meltdowns is a great way to beat the benchmarks.
5. BUILD A FUNDAMENTAL SANDBOX WITH A HISTORY OF BEATING THE BENCHMARKS
No single element of your investment strategy will provide you with significant benchmark out performance. To optimize return, you need to earn it through combining a number of factors, both fundamental and technical. The first step is to build a fundamentally strong sandbox that chooses securities based on quantitative factors that have consistently beaten the benchmarks. If you start with a sandbox of securities that, in aggregate, beats the benchmarks, you have set the stage for your other factors for additional performance.
6. OWN STOCKS WITH A HISTORY OF BEATING THE BENCHMARKS
Quantitative analysis programs allow us to sort stock performance over a number of periods, from one month to twenty years. Through this analysis, we can identify the companies that have consistently out performed the benchmarks. Over longer periods of time, stocks have a difficult time out performing their fundamentals. If earnings growth, for example, is stronger for a company than the composite of all companies listed on an index, it will likely out perform the index. By including these companies in your fundamental sandbox, you take another step in improving your performance against the benchmark.
7. PURCHASE AND HOLD SECURITIES WITH A STABLE AND LONG-TERM GROWTH IN EARNINGS AND DIVIDENDS
By focusing on earnings and dividend growth, we can get a clear picture of the ability of that firm to grow. Although past performance is not a good indicator of future performance, identifying companies with long-term, strong growth rates in earnings and dividends, we improve the ability to beat the benchmarks by investing in strong companies and minimizing major losses in your portfolios.
8. AVOID SECTORS THAT ARE EXPERIENCING NEGATIVE PERFORMANCE AGAINST THE BENCHMARKS
We call this factor “addition by subtraction”. By avoiding sectors and stocks with a history of under performing the benchmarks, we improve our ability to beat the benchmarks. A simply way to look at this is to compare long-term performance of growth companies, that generate consistent growth in earnings to cyclical companies, such as those who are dependent on commodity prices like energy or metals and mining. Although cyclicals can have periods of strong performance, over time, the peaks and valleys often result in poor performance.
9. USE 6 or 12-MONTH MOMENTUM TO FOCUS OWNERSHIP OF SECURITIES IN STRENGTH AND AVOID WEAKNESS
Will Rogers once said “Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.” The traditional industry approach of buying stocks that are down and selling them when they go up (Buy Low/Sell High) unfortunately hasn’t proven to be the best approach. Sure, it is the only way to make money in cyclical stocks like energy and metals and mining but good companies that have strong and consistent earnings growth don’t give you many buy low opportunities. These companies consistently beat the benchmarks and “Buy High and Sell Higher” is a better approach with these companies.
10. BUILD CONCENTRATED PORTFOLIOS
Concentration is one method of beating the benchmarks. By holding a small number of stocks in a portfolio, you increase potential return but also risk. In What Works On Wall Street, the author demonstrates that the top decile of stocks that have the best momentum over a three to six month period, out perform the all stock universe by 3.65% per year over an 83 year period. To counter act the risk factor of concentration, we diversify our sandboxes so we are buying the best companies from a variety of exchanges.
11. CUT LOSERS AND LET THE WINNERS RUN
You can only make good decisions if you know the numbers behind an investment strategy. Two quantitative measures that are important to track are the percentage of winners to losers and the average winner compared to the average loser. To beat the benchmarks, you need to have a high percentage of winning trades and a wide gap between the average winning trade that the average losing trade.
12. FOCUS ON AND TRUST THE PROCESS
The number one factor on this list is “Follow a Rules-Based Approach”. Once you spend the time developing and testing your system, it is critically important to trust the system. If you find, over time, that the system needs to be updated, build and test a new system but don’t make changes until you have proven that the new system is going to perform better than the old system. Until then, trust your process and don’t second guess it.
13. MINIMIZE DECISIONS BASED ON INTUITION
The human brain is not wired to make complex financial decisions. Emotions, like fear and greed, constantly get int he way. We fall in love with stocks and hold them when the fundamentals are falling apart and can’t stomach purchasing a stock that has recently doubled, even though the fundamentals are strong. Most advisors and investors under perform the benchmarks because they rely too heavily on intuition and experience.
14. FOCUS ON BUNDLES OF STOCKS RATHER THAN INDIVIDUAL STOCKS
Most stocks are much too volatile for the average investor. Even stocks, like banks, can have huge swings in value. This volatility makes it much to difficult to maintain confidence and composure and make good decisions. Buy diversified bundles of stocks and then focus totally on the movement of the value of the bundle and minimize watching the daily price swings of the individual stocks.
15. MINIMIZE “NOISE”
As investors, we are bombarded on a daily basis with information. Stocks look good and stocks look bad. The Fed is going to raise interest rates or Saudi Arabia is going to reduce oil production. Warren Buffett is buying or selling. Banks are undervalued or overvalued. If you want to beat the benchmarks, you need to minimize “noise” and focus onto process.
16. AVOID THE TEMPTATION OF BUYING STOCKS THAT ARE FALLING
When a stock is in a free fall, it looks cheap. Investors rush out to buy stocks that are on sale, just like Boxing Day shoppers. Falling stocks are only inexpensive when the fundamentals are not falling apart at the same time. We should have all learned this lesson from stocks like Blackberry and Nortel. Would you bet money on a last place sports team turning their fortunes around at mid season? Stocks like this often end up in a pile with the Boxing Days specials that you didn’t really need but bought simply because it was a good sale.
17. DON’T REBALANCE AGGRESSIVELY
The reason that investors rebalance their portfolios is to reduce risk. Unfortunately, rebalancing feeds the process of selling winners and buying losers. This is the way we were all trained, right? So, we sell a stock that has consistent annual earnings growth of 25% because it has tripled and now if too high a percentage of the portfolio and buy a stock whose earnings is growing at 5%. This approach, like many others, will result in benchmark under performance.
18. REVIEW YOUR POSITIONS ON A SCHEDULE RATHER THAN DAILY
If you only hold good stocks that are in positive uptrends, why do you check the prices on a daily basis? Daily review and and analysis is another form of “noise”. A one percent drop in the value of a stock can get your emotions running. Spend your time talking with your clients and building your business. This will pay dividends for both your clients and the growth of your business.
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This post was originally published by Bob Simpson, Synchronicity Performance Consultants
Copyright © Bob Simpson, Synchronicity Performance Consultants
