This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.
Crowded Trades and Alpha Don’t Go Together
Sometimes the 'prettiest' stocks today aren't the best option for tomorrow
John Maynard Keynes was fond of referring to the stock market as a beauty contest. In trying to pick stocks that will do the best, investors commonly try to pick those equities that, in their opinion, look the most attractive to others. This sort of mindset, according to Keynes, results in the trade of herd behavior that results in extremely crowded trades.
A recent Wall Street Journal article shows that an opposite approach where the most unattractive stocks are selected have actually done better. This makes some sense, as the most sought after positions are the most expensive from a valuation standpoint. Meanwhile, the forgotten bottom tier can represent compelling valuations.
So if the trick isn’t to pick today’s most popular investments, then perhaps the best route to consistent alpha generation is in finding stocks that have the potential to be the “prettiest” in the future. Some potential candidates today may be in mortgage securities (which I discuss in the cover story in the January issue of Investment Advisor), or the beaten down municipal bond sector. To find tomorrow’s beautiful swan, it seems one must be willing to examine a few ugly ducklings.
Individual investors shouldn’t fret that they are often caught in the most popular, but usually less profitable, securities. It seems that professional investors tend to act in the very same way.
About the Author
Ben Warwick, Quantitative Equity Strategies
Veteran investment strategist Ben Warwick brings 20 years of investment management expertise to AdvisorOne.com in his blog, Searching for Alpha. His market and economic insights provide readers with an insider’s view on generating alpha through asset allocation, the use of strategic portfolio “tilts” and alternative investments.
Ben Warwick founded Quantitative Equity Strategies (QES) in 2002 as a platform for implementing his quantitative investment strategies. The firm manages assets with traditional long-only equity and fixed income, private equity, managed futures and alternative investment mandates. QES has developed an industry leading expertise in building investment programs that can replicate alternative returns, while offering daily liquidity and transparency. These products include the HFRq, a hedge fund replication strategy developed in concert with Hedge Fund Research in Chicago; the Managed Futures Beta Index, with Aspen Partners; and the Nomura QES Modeled Private Equity Returns Index (PERI), which was developed with Nomura Bank and Preqin, the leading source of information in the private equity industry.
He is the author of several books, including "Searching for Alpha: The Quest for Exceptional Investment Performance," (Wiley, 2000) and "The Handbook of Managed Futures," with Carl Peters, (McGraw-Hill, 1996). He can be reached at ben@qesinvest.com.
Comments
