Why Do Investors, That Are Given Proven Strategies That Work, Still Underperform

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In his recent interview with Tobias, Adam Butler, CIO of ReSolve Asset Management discusses why investors that are given proven strategies that work, still underperform. Here’s an excerpt from the interview:

Adam Butler: Absolutely. And I just love the story of … Oh, what was his name? Greenblatt, right? So, Greenblatt writes this book. What’s it called?

Tobias Carlisle: The Little Book That Beats The Market.

Adam Butler: The Little Book That Beats The Market, right? And he’ll know what the exact specifications are for his model, but it’s got something to do with ROE and some value metric.

Tobias Carlisle: Right. EV/EBIT, earnings yield.

Adam Butler: Yeah, there you go. Yeah, yeah, yeah. So, he’s been very successfully using this strategy to manage his hedge fund, which has done spectacularly well for over a decade. We’re talking what? 25, 30% annualized returns. Just something just absurd. And so then he shares this formula with the world and then he creates this service where he allows people to invest in this model so they give them money to this service, and there’s two ways that you can take advantage of this service.

Either you can just let the service run the model for you systematically. So obviously, you’re taking all buys and sells that are spit out by the model, or the service will give you the stocks that you need to buy and sell and then you can go and buy and sell them on your own.

Adam Butler: And then a few years later, he examined the performance of the accounts that had just allowed the service to run the trades versus the accounts of the investors who had been given the trades and had to execute on their own. And the accounts that had systematically executed the trades had just vastly outperformed the accounts that had discretionarily executed the trades, presumably because the people did not take all of the recommended trades, right?

They looked at some of the names on the list and were like, “Wow, these are getting a lot of garbage coverage in the press or, “Hey, they say I should sell this stock but look at all the great things it’s doing, look at it’s earnings growth, whatever,” right? So, they’re overlaying their own bias.

Adam Butler: So, this is a perfect example of that the system sets the upper limit and all you can do with your discretion for the most part is detract from the results.

Tobias Carlisle: He wrote it up as an article in Morningstar called Adding Your Two Cents Will Cost You A Lot. And what he found was the model over the two years that he tracked it returned 84%, the market did 65%, so it outperformed the market materially. And then the average of the accounts that cherry picked, the discretionary accounts was like 54%. So, they actually underperformed the market and the model.

Adam Butler: Love it. Yeah.

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