Unfashionable Investing

Investors such as mutual funds, index funds, and hedge funds tend to pick a particular strategy or asset type and stick with it. It’s what they know, it’s what they’re known for, and making major changes would often create legal difficulties; something marketed as a bond fund can’t suddenly switch to stocks even if they think stocks would do much better. Other types of investors like pension funds, endowments and individuals have more flexibility to change their strategies. These investors tend to chase performance, allocating to types of investments that have performed well recently. This can create fashions, types of investment strategies that become more popular for a few years.

These strategies might involve focus on a certain asset class (stocks / bonds / commodities / private equity / real estate / et c), a certain sector or region within an asset class, a certain factor (value, growth, momentum), et c. It seems like institutional incentives, trend chasing, and FOMO lead people and institutions to over-allocate to strategies that have been successful the last 1-5 years and under-allocate to those that haven’t. Everyone sees something has recently been successful, so they pile into it, which drives up prices and makes it look even more successful for a while; but eventually this drives things to be so clearly over-valued that there’s a crash, and the crash scares people away for years until it becomes clearly undervalued. Most recently 2020-2021 saw people pile into growth/tech stocks and alternatives like SPACs/crypto, but the beginning of Fed rate hikes was the signal that the party is over and people (over?)react by pulling out.

Given this, the ideal strategy is to show up right before the party starts, then leave right at the peak; but no one can time it that well. The possibly realistic alternative is to show up early when no one’s there, then leave right when the party’s getting good (Punchbowl Capital?). Timing and identifying which strategies are too hot and which cold enough (Glacier Capital? Cryo Capital?) is the biggest practical question in how to pull this off. The simplest/dumbest way to do it is to avoid timing decisions entirely and just invest fixed proportions into all strategies; when they’re over-valued your fixed investment doesn’t buy many shares, when they’re under-valued it buys lots. This actually sounds like a decent way to go, but its more buying into the Efficient Market Hypothesis than beating it, can we do better? Here are the types of meta-strategies I’m planning to look into:

  • How variable is the timing of strategy boom/busts? Could you possibly just use fixed numbers of months/years- if a strategy’s been hot this long get out, if its been cold this long get in?
  • Use market share numbers, get in when something gets below a certain % of the market and out when it gets above
  • Use valuation numbers like P/E ratios (seems to work well for the overall stock market, may be harder to measure for some strategies/classes)
  • Flow of funds- is there a rate of change that works as a trigger?
  • Proportion of major institutions allocating to each strategy
  • What looks promising right now along these lines (May 2022)? Without looking at the numbers, the perennial strategies that have been out-of-favor a few years seem like value, emerging markets, and commodities (though commodities might be too hot again just now). These (along with real estate; right now homes seem expensive but homebuilders are cheap and I think commercial is too) all did well after the 2000 tech crash

I’m obviously not the first person to think along these lines; the concepts of the commodity cycle and Shiller’s CAPE are related, and Global Macro and Multistrategy funds do some of this. In the latest AER: Insights, Xiao Yan and Zhang echo Robert Shiller and Paul Samuelson that predicting big things like this is actually easier than predicting little things like the valuation of a specific stock:

Samuelson’s Dictum refers to the conjecture that there is more informational inefficiency at the aggregate stock market level than at the individual stock level. Our paper recasts it in a global setup: there should be more informational inefficiency at the global level than at the country level. We find that sovereign CDS spreads can predict future stock market index returns, GDP, and PMI of their underlying countries. Consistent with the global version of Samuelson’s Dictum, the predictive power for both stock returns and macro variables is almost entirely from the global, rather than country-specific, information from the sovereign CDS market

Ungated version here

But I haven’t actually heard of any fund focused on “unfashionable investing” that considers all asset classes and strategies like this. What institution out there would be capable of saying in 2021 “growth stocks are at bubbly levels, we’re switching to commodities”, or saying in 2022 “commodities are high and growth stocks crashed, we’re switching back”? Please let me know if such an institution does exist, or what else to read along these lines.

2 thoughts on “Unfashionable Investing

  1. Ryan June 2, 2022 / 11:50 am

    Momentum investing is well studied and you generally see time periods in the 3-12 months range perform very well (note that a 12m momentum strategy is investing in trends that have a much longer lifetime than 12m since it takes time for the signal to develop and then more time for the signal to dissapear).

    That being said, momentum itself has periods of boom and bust so at sufficient levels of abstraction you start recursively playing the same “is it overvalued?” guessing game with momentum and every other investment strategy.

    >What institution out there would be capable of saying in 2021 “growth stocks are at bubbly levels, we’re switching to commodities”
    Many (if not every) asset manager will have that sort of conversation internally, and some will even publish their thoughts (ex https://www.gmo.com/americas/ ) but the problem is that making these sorts of calls at scale is extremely dangerous. They are very timing sensitive and can take years to pay off, and raising/keeping money is very hard if you are doing something that conventional wisdom considers stupid. Even if your timeing is near-perfect you still risk trailing by 30-50% at the end of a cycle since the crowd psychology accelerates.

    In general if you can agree with everything an investor is doing their performaice is probably going to be mediocre at best. In retrospect my reaction to every great call has been closer to “I see why you believe that will work, but I’m not sure I want to participate…”. But if you want to raise money you need to look more like that first investor and less like the second one.

    FWIW if I were trading my own money I would start with momentum and fund flows so my thinking is relatively similar to yours.

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    • James Bailey June 4, 2022 / 6:21 am

      “a 12m momentum strategy is investing in trends that have a much longer lifetime than 12m since it takes time for the signal to develop and then more time for the signal to dissapear”
      Huh, I knew about momentum strategies but didn’t think of them as relevant on the time horizons of years because I didn’t consider this angle

      Like

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