Strategies: In Investing, at Least, It Makes Sense to Play for a Tie

Frank Deford, the sportswriter, has drawn another conclusion about our national preferences: Americans don’t like losing, but what we really can’t stomach is a tie.

In a tongue-in-cheek radio commentary, he noted the oft-repeated observation that “a tie is like kissing your sister,” adding that “if there is one thing the red states and blue states can agree on, it is that.”

In 1996, college football eliminated ties, and the National Hockey League banished them in 2004. Ties are still frequent in soccer — but that may explain why that beautiful game is more beloved abroad than in the United States. Our distaste for ties, Mr. Deford says, “is one thing that sets us sons of liberty apart from most of the rest of the world.”

Playing for a tie may go against the grain of most American sports, but it should be central in investing. That’s because a core finding of modern finance theory is that we don’t need to beat the market. In fact, for most of us, once we’ve decided how much risk we want to bear, a better approach is aiming to tie — or match — the market return.

That’s the message of William J. Bernstein, an investment adviser and author, most recently, of the e-book, “Skating Where the Puck Was.” Periodically, Mr. Bernstein says, some investment manager discovers a way to generate outsize returns. Whether the favored asset class is Internet shares or gold bullion or oil futures or mortgage-backed securities, the new market-beater isn’t likely to last.

“As soon as one gets discovered, it’s already gone,” he writes. Matching the market is the best that most of us should hope to do.

Much the same insight appears in new research by two finance professors, R. David McLean of the University of Alberta and the Massachusetts Institute of Technology, and Jeffrey Pontiff of Boston College. The professors analyzed 82 academic studies that came up with ways of outperforming the market.

In their paper, they found that as soon as these methods were published, their efficacy began to decay, probably because other investors soon copied them. The paper, available online, is titled “Does Academic Research Destroy Stock Return Predictability?”

In an interview, Professor McLean said, “After publication of a paper about an investing strategy, on average, the performance of that strategy decayed by 35 percent.”

The professors didn’t assess the actual costs of putting any of these strategies into effect, but it’s likely that the costs outweigh the benefits for individual investors. “I doubt that it would make sense for most people to try them at home,” Professor McLean said.

And Professor Pontiff added, “I tell my own students that the core of their own personal investments probably ought to be a low-cost index fund that mirrors the market.”

IN his e-book, Mr. Bernstein acknowledges that some talented people do manage to beat the market, at least for a while. Some move ahead of the pack by discerning opportunities on a new financial frontier. But such vision is rare and such opportunities are fleeting. “It does happen, and people try to copy them, and that’s the problem,” he said in an interview.

In his book, he cites the late Sir John Templeton, who started a mutual fund, Templeton Growth, that was among the first in the United States to invest extensively abroad. In 1970, Mr. Bernstein says, Japanese stocks constituted 60 percent of the fund, and it performed splendidly. But as other foreign investors bought Japanese shares, and as global market performance became more correlated, that outperformance faded, Mr. Bernstein says. (Mr. Templeton was adept enough to shift the fund’s focus and find other opportunities.)

Similarly, Mr. Bernstein says, David Swensen, manager of the Yale endowment, took the “radical” step in the 1980s of moving more than half of the endowment’s assets into alternative asset classes like hedge funds, private equity, real estate and commodity futures.

Mr. Swensen was way ahead of most investors, and his strategy worked brilliantly, Mr. Bernstein writes. From July 1987 to June 2007, Mr. Swensen’s annualized return was 15.6 percent, Mr. Bernstein says, 4.8 percentage points higher than the Standard Poor’s 500-stock index. “Better yet, along the way, the endowment experienced considerably less volatility,” the author adds.

Mr. Swensen’s unusually strong record inspired copycats. The Yale model spread throughout university endowments and public and corporate pension funds, and nearly everyone tried to beat the performance of everyone else. The results were all too predictable, Mr. Bernstein says.

“As a dismal but useful rule, most good investment ideas eventually get run into the ground,” he writes. Lately, the performance of university endowments, including Yale’s, has been less impressive. Over the three- and five-year periods that ended in mid-2011, he says, a simple balanced index fund portfolio, 60 percent in stocks and 40 percent in bonds, beat the average university endowment. And putting money in the balanced index fund requires no skill and minimal fees.

The alternative approach — trying to duplicate the experience of a pioneer — is where Mr. Bernstein’s book title comes in. Copying exceptional strategies is like “skating where the puck was,” he says. As Wayne Gretzky, the hockey great, was taught by his father back when the N.H.L. still had ties, it’s better to skate where the puck will be.

That’s hard to do, though, and very risky. Mr. Bernstein, a retired neurologist based in Portland, Ore., says it’s better to play for a tie by assessing how much risk you are able to bear, allocating the assets in your portfolio carefully and using low-cost index funds to match the market’s returns.

Professor McLean adds that even if you identify a market anomaly that suggests a profitable strategy — overweighting small-cap value stocks, for example — you might use low-cost index funds in that category to exploit it. Match the performance of these market sectors, he says. You don’t need to take on extra risk by trying to beat them.

That’s why the metaphor for this approach may come from soccer, after all: sometimes the smartest strategy is just playing for a tie.

Article source: http://www.nytimes.com/2013/01/13/your-money/in-investing-at-least-it-makes-sense-to-play-for-a-tie.html?partner=rss&emc=rss