Dissection of an Investment Presentation (Part 6)

Today I will conclude analysis of the investment presentation referenced here.

The third-to-last slide discussed lists managed account formats and related information. Formats exist for “Market Series” and “Factor-Enhanced Series” accounts. This presentation has focused on the latter. Formats include “UMA Sleeve,” “SMA Beta,” “SMA Tax-Optimized,” and “SMA Custom.” Minimum investment ranges from $60,000 to $750,000.

The penultimate slide lists investment management fees. The factor-enhanced “quantitative portfolios” (QPs) range from 0.20-0.25%, which it states is 5-10 basis points above average. This is cheap compared to the standard 1% fee most financial advisors charge, which includes non-investing services. It’s not as cheap based on my incremental value calculations. I think a big difference exists between investment styles, though. This appears to be a passive, plain-vanilla investment offering that generates subpar performance yet still represents significant improvement. Mine is an active investment approach.

The summary slide says the factor-enhanced QPs “deliver the potential for excess return.” This may be the best line of the whole presentation. Many things have potential. This is no guarantee nor is it an exaggerated conclusion drawn from the content provided.

This line suggests everything in the presentation amounts to circumstantial evidence, which relies on inference to support a claim. Plenty of instances have been discussed where incomplete or flawed logic begs inference to overlook. In Part 1, I talked about potential data-mining bias. In Part 2, I talked about incomplete/empty phrases that work well for sales and marketing. In Part 3, I analyzed performance graphs potentially related to but not direct portrayals of the factor-enhanced QPs. In Part 4, I mentioned missing analyses of the very important drawdowns and flat times. In Part 5, I talked about a number of irrelevant labels sounding professional and persuasive.

Circumstantial evidence is one step below direct evidence. I mentioned a lack of supporting evidence several times throughout this dissection. A large emphasis of sales and marketing [advertising] is staging circumstantial evidence to persuade. I suspect many people fail to realize what is missing. People may also get distracted from the fact that the evidence is incomplete. The presenter (or presentation) can achieve this any number of ways such as with establishment of rapport, with emotional appeals or humor, with polished public-speaking skills, etc.

At the end of the day, this is another instance of performance omission by an investment manager. Eleven other such mentions were given in this blog series. At the very least, I think this investment offering is as good as any other. While professional and somewhat convincing, however, given the circumstantial nature I certainly would not bet on outperformance.

Dissection of an Investment Presentation (Part 3)

Today I continue studying the investment presentation referenced here.

     > …important characteristics of the momentum and value factors
     > is their negative correlation… meaning value tends to work well
     > when momentum is not… and momentum works well when value is
     > idle. So each factor adds value on a standalone basis but
     > their negative correlation makes them an excellent combination
     > for potentially increasing risk-adjusted returns.

“Negative correlation,” which is arguably the “Holy Grail” of diversification, is a great marketing buzz phrase.

One problem is that correlation changes over time. During some of the most severe market declines, negative correlations have turned positive and approached +1.00. This means everything loses. The presentation says from 12/31/1926 – 12/31/2014, correlation of value and momentum was -0.40. This doesn’t tell us how things look at the extremes (when correlation becomes most positive) or what the overall distribution looks like (how often the negative correlation persists). An unstable parameter with large mean excursions coinciding with big losses is probably not a viable trading concept.

At worst, this could completely invalidate momentum and value factors as edge provided by their investing approach.

Here is their graph of factor performance:

Over 88 years, $1 grows to $329 and $32 for momentum and value factors, respectively. That sounds impressive!

This is a good time to review my general recommendations for viewing an investment presentation:

1. Do not be blinded by the light: their job is to make things look good.
2. Accept no comparison without assessing the comparator.
3. Challenge everything.
4. Do not accept any claims without supporting evidence (added after Part 3).

No available comparator violates #2. We cannot see how the investment performed when not tailored toward momentum or value. A terminal value of $350, for example, would be reason to reject both factors.

Drawdown (DD) analysis is important enough to render any presentation lacking it very limited in application. DDs determine whether we can remain invested in a strategy. I have written about the importance of DDs here, here, here, and here.

With regard to #3, I see the graph omits DD analysis by showing growth of $1. The account would never actually start with $1 and the maximum DD of both curves may even exceed the initial value. Any such equity curve would, in reality, be terminated early due to Ruin (account going to zero).

In other words, growth of $1 to $350 simply would never have happened. The initial account would need to be larger to trade this strategy over the entire 88 years. Adding initial equity dilutes returns. Instead of 35,000%, realistic growth could be 3,500%, 350%, or less. The bloom is off the rose.

The presentation continues with this slide:

For me, the line graph begs an immediate question: how does this line graph differ from the first one? Both graphs show value and momentum factors. Both show growth of $1. Both cover a similar time interval. Why does momentum in the latter graph only grow to $272 (rather than $329) while value grows to a whopping $44 (rather than $32)? Those are huge differences for a subtraction of one year (or less), which is only a 1.1% difference on 88.

I also wonder why the time intervals are different at all. The first graph is “12/31/1926 – 12/31/2014” and the second is “1927-2014.” Were they just sloppy in reporting the same time interval? If they used the same interval then what/why was the difference in how they defined factors? Did they do their own research or “borrow” data from others?

Consistency breeds credibility and [especially] when consistency is lacking, explanation should be given. None is given here, which violates #4. I question the accuracy of their calculations. I also question their underlying motives. Were they trying to artificially inflate certain numbers to serve their purpose? Remember #1, above.

Dissection of an Investment Presentation (Part 2)

Today I will continue my exemplar of things to watch for when viewing a financial presentation.

Remember my general recommendations:

• Do not be blinded by the light: their job is to make things look good.
• Accept no comparison without assessing the comparator.
• Challenge everything.

The presentation continues:

     > A significant amount of academic and industry research has focused…

Incomplete phrases like these are easy to challenge:

• Who determines significance?
• Who did the research?
• Who funded the research?
• What conflicts of interest were present?
• When was the research done?
• What was the research methodology?

All this information can help us to determine validity of the conclusions.

No responsible, advanced trader is going to accept empty claims just because they appear in a presentation. This can only serve marketing/advertising purposes in an attempt to persuade the gullible.*

This same lack of evidence is why I disregard other traders’ claims about their own personal investment success. I have written on this subject here and here. I write about my own performance every now and then to hold myself accountable. I do not expect you to take anything from those posts.

Remember, too, that finance and investing are all about the money. Somehow, I feel this puts us more at risk for fraud than other industries. As a public service announcement, go back and read some of my other posts on fraud to increase awareness and protect yourself (e.g. here, this whole mini-series, or any of my optionScam.com posts).

     > …on the tendency for assets that have performed well over the past
     > year to continue to perform well over the near term.

I need to know much more to evaluate these claims. Drawing conclusions from one and only one parameter value is shortsighted (e.g. here, here, and here). I would rather see discussion of a range and why they selected 12 months.

These comments regarding momentum also apply to the value factor.

This presentation is clearly intended to be more for marketing and advertising than it is research because the latter would not omit so much critical information. I try to avoid being sold by any presentation lacking critical information. I would highly recommend you do the same.

     > Why have we selected momentum and value as the two factor
     > exposures we attempt to maximize? Of the several hundred asset
     > pricing factors researchers have identified over the past few of
     > decades, there are only a few that stand the test of time and
     > remain statistically significant through various market cycles.
     > Of those few, momentum and value are among the most robust.

I discussed last time why the “several hundred” detail is irrelevant if not damning.

Hard data is needed to fulfill claims that momentum and value have “stood the test of time” and are “statistically significant.”

Again, do not accept hollow statements in a presentation without understanding the supporting (or lack thereof) evidence.

I will continue in the next post.

* This arguably includes many people. The financial industry likely gets away without reporting performance, in large part,
   for this reason alone.

Dissection of an Investment Presentation (Part 1)

Investment presentations often sound quite tantalizing. Critical thinking must be applied in order to assess what meat (if any) is actually there. The video referenced here is accessible over the internet. Today I will begin to discuss my thoughts as an exemplar of what to look for in such a presentation.

Here are a few general recommendations to keep in mind. First, do not be blinded by the light: their job is to make things look good. Second, accept no comparison without assessing the comparator. Finally, challenge everything. Anything that can withstand such scrutiny and still come out looking impressive is probably deserving of closer attention.

     > Quantitative Portfolios combine the benefits of passive
     > investing with the portfolio customization of managed

“Quantitative Portfolios” is a complex-sounding eight-syllable phrase. Capitalizing “portfolios” makes it seem like an advanced product. Quantitative just refers to numerical measurement rather than semantic description. Most portfolios are quantitative because some number is calculated somewhere. “Quantitative Portfolios” could therefore be much ado about nothing.

Passive investing usually misses the benchmark due to tracking error and expense fees. This falls under my category of subpar returns and right off the bat, I suspect this might be a garden-variety offering.*

     > accounts… low cost access… with opportunities for

“Low cost” is also suggestive of a garden-variety offering because I don’t believe the intellectual capital (including dedicated quantitative analysts) needed to boost a garden-variety strategy to something more optimal comes cheap.

     > personalization and tax management.

I think [portfolio] “customization” and “personalization” are best used as marketing buzzwords.*

Tax management can be useful but hard to measure.*

     > Factors are the basic building blocks determining an asset’s
     > risk and return… since [1990s], hundreds of… factors have
     > been researched.

Researched by whom and to what extent? Some sort of reference would be useful.

The seeds for data-mining bias are planted here. By chance alone, an exhaustive (i.e. “hundreds”) study of historical data will usually turn up at least a couple highly-correlated relationships. Correlation does not imply causation, however. This is not the best way to identify relationships likely to be predictive of the future.

     > Both the momentum and value factors have been heavily
     > researched for at least 20 years by leading academics and
     > industry practitioners and used extensively in practice by
     > well-known quantitative investment managers.

I have read about the advantages of focusing on momentum and value over the years. Familiarity breeds credibility. This is important to recognize for the sake of objectivity.

The sentence sounds matter-of-fact and official, which can be very persuasive. Dig a bit deeper, though, and we can see that critical information is omitted:

• Who are these “leading academics?”
• Are they skilled investors (i.e. is there reason to think this might be actionable)?
• To assess quality of the research, what are meant by “extensively” and “well-known?”
• Have the investment strategies outperformed benchmarks and increased AUM for the firms involved?
• What do the drawdown distributions look like?

These unanswered questions can raise doubt about validity.

Finally, most investment categories (e.g. active, passive, hedge funds) represent significant improvement. I [optimistically] assume that at some level, all approaches are managed/developed with “heavily researched” factors and “leading academics” doing the work. This limits the positive impact of the whole statement to something less than optimal.*

I will continue next time.

* These are good topics for future blog posts.