Investment Insights Podcast – The Good and Bad of Trading on Emotion

Raupp_Podcast_GraphicJeff Raupp, CFA, Senior Investment Manager

On this week’s podcast (recorded January 26, 2016), Jeff looks at the opportunities created via emotional selling while monitoring the negative factors at work in the economy:

  • Leading reasons for weakness in the marketplace continue to be falling oil prices and China’s slowing growth
  • Strength of the global economy is creating uncertainty.
  • When markets are volatile, it’s important to evaluate where markets may have overreacted and opportunity has been created.
  • Emotional trading seems to have generated attractive entry points into the market, but unique to an investor’s risk tolerance and time horizon.
  • Positives in the market include tame inflation and accommodative monetary policy; negatives include overtightening by the Federal Reserve.

For Jeff’s full insights, click here to listen to the audio recording

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

Chasing Markets

Jeff RauppJeff Raupp, CFA, Senior Investment Manager, Brinker Capital

Back when I was in the U.S. Army, one thing I dreaded was the two-mile run as part of the Physical Fitness (PT) Test. I am not a runner. While most people would scoff at the notion of a two-mile run being intimidating, I looked at it as 13-14 minutes of pain. It was timed, and the better finishing times naturally resulted in a better score. Seemingly anything above 15 minutes resulted in a fail and, of course, more running.

One of the things I had the most trouble with was finding the right pace. I’d have instances where I’d try to run a balanced race only to end up having to sprint the last few hundred yards to reach my desired time. Then there were the times where I’d go out too hard and find myself stumbling into the finish line. The hills on the courses would complicate things – I’d kill myself trying to keep a constant pace uphill and downhill.

shutterstock_175699433After struggling with this for months, I came up with a better solution. We always ran as a group, and I found that I could usually find a few people that would consistently run around the same time I was looking for. Then my objective would be to keep up with them knowing that as long as I finished somewhere in their vicinity, I’d hit my goal.

The other day someone asked me whether investors’ financial goals should be to try to outperform the market, and with my response I thought there were a lot of similarities to my past running strategy.

An investor starts with an objective they’d like to get to, how much money they have, expected cash flows and their time horizon. From there it’s a matter of finding the right mix of asset classes that historically has shown a high probability of achieving the returns necessary to reach the objective(s). That mix can be thought of as your strategic plan.

Along the way, the market is a useful reference point. Investing isn’t a smooth journey, so when your strategy has drawdowns or grows faster than you expected, knowing how markets performed helps you determine if that’s just market volatility or if something may be wrong with your plan. Changing your strategic plan along the way can be dangerous, particularly at market extremes. If you’re always chasing the runner that looks the strongest at the moment, there’s a good chance you’ll burn out before the finish.

The views expressed are those of Brinker Capital and are for informational purposes only.

Investment Insights Podcast – February 5, 2015

Raupp_Podcast_GraphicJeff Raupp, CFA, Senior Investment Manager

On this week’s podcast (recorded January 31, 2015):

What we like: Yields on investment-grade and high-yield corporate bonds have moved higher; credit is strong fundamentally; investors indiscriminately selling credit securities

What we don’t like: Impact of lower oil prices on energy companies; possible creation of defaults

What we’re doing about it: Keeping current weight to credit, but opportunities arising due to credit selling; monitoring falling oil prices

Click here to listen to the audio recording

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Simple is Better

Jeff RauppJeff Raupp, CFA, Senior Investment Manager, Brinker Capital

Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it’s worth it in the end because once you get there, you can move mountains. ~Steve Jobs

If you can’t explain it simply, you don’t understand it well enough. ~Albert Einstein

As an aspiring young basketball player in my pre-teens, I was fortunate enough to have my dad coach my township basketball team. When watching him draw up and teach a play for our team to execute, I decided I, too, could design a play for us. I guess I had always been a bit of an analytic. I went home and proceeded to design what might have been the most complex play ever developed, involving multiple players setting multiple picks, variations depending on how the defense reacted, and multiple passes that required each player’s timing to be nothing less than perfect. I proudly showed it to my dad. He appropriately praised me for the effort and then, to my dismay, declined to implement it Play Callingat the next practice. Naturally, I bothered him incessantly about it, as only kids can do, until he finally sat me down and walked through the play. He pointed out that while on paper the play looked great, if the execution or timing was even slightly off for any of the players, the entire thing broke down. As a team, we were still grappling with the idea of executing a simple pick and roll, so a play this complex was destined for failure. For our basketball team, simple was better.

Years later, I have found this lesson to be applicable in so many cases, particularly in investing. When you think of all the factors that can affect returns—economic factors, geopolitical issues, company specific factors, investor sentiment, government regulation, etc.—the tendency is to think that to be successful in such a complex environment you need to come up with a complex solution. Like my basketball play, complex investment solutions can often look great on paper, but fail to deliver.

I’ve interviewed hundreds, if not thousands of investment managers covering any asset class you can imagine. One of the things I’ve learned over the years is that if I can’t walk out of that interview with a good understanding of the key factors that will make their product successful and how that will help me, I’m better off passing on the strategy.

An instance that stands out to me is the time I visited a manager where we discussed an immensely elaborate strategy that tracked hundreds of factors to find securities that they believed were attractive. We visited the floor where the portfolio was managed by computing firepower and a collection of PhDs that rivaled NASA. You really couldn’t help but be impressed by the speed at which their systems could make decisions on new data and execute trades, and the algorithms they used to optimize their inputs used just about every letter in the Greek alphabet.

Raupp_Simple_3.28.14_1The conversation then went towards discussing how all of this translates to performance and it hit me—all of this firepower didn’t produce a result that I couldn’t get elsewhere from cheaper, less-complex strategies. So while I could appreciate all the work that went into putting the strategy together, I had a hard time seeing how the end results helped our investors. I felt that in creating an intellectually impressive structure, the firm had lost sight of the bottom line—delivering results to their investors.

This isn’t to say that all complex investment strategies aren’t worthwhile. We use many in our portfolios and over the years they’ve added significant value. We spend a lot of time analyzing the types of trades and opportunities that these managers look for and use. But I’ve found that if I can’t step back and articulate why I’d use a strategy in three or four bullet points, I’m better off walking away.

Most of the time you’re better off with the simple pick and roll.

The views expressed are those of Brinker Capital and are for informational purposes only.

Everyone’s Unique

Jeff Raupp Jeff Raupp, CFA, Senior Investment Manager

Whenever I go to the bowling alley it strikes me how unique people are. And no, it’s not because of the multi-colored shoes or even the matching team jackets complete with catchy names like “Pin Pals” or “Medina Sod” sewn on the back. It’s because of the bowling balls.

Every time I head to the lanes, I can bank on spending at least ten minutes trying to find a ball that works for me. You have the heavy balls with the tiny finger holes and the huge thumb, the balls with the finger holes on the other side of the ball away from the thumb, and the ones where it seems like someone was playing around and drilled three random holes. Half of the time I find myself weighing the embarrassment of using a purple or pink ball that feels okay versus a more masculine black or red ball that weighs a ton but can only fit my pinkie. I’m always left thinking, “Where’s the guy or gal that this ball actually fits?”

Raupp_Everyones_Unique_2.14.14But at the end of the day, I find that if I find the right ball, where my hand feels comfortable and the weight is just right, I have a much better game.

In the same way, how to best save toward your life goals is unique to each investor. Even in the scenario where two investors have the same age, same investable assets and generally the same goals, the portfolio that helps them achieve those goals may be decidedly different between them. Investor emotion can play a huge role in the success or failure of an investment plan, and keeping those emotions in check is vital. There is nothing more damaging to the potential for an investor to meet their goals than an emotional decision to deviate from their long-term strategy due to market conditions.

Fortunately, there’s often more than one way to reach a particular goal. There are strategies that focus on total return versus ones that focus on generating income. Strategies that are more market oriented versus those that look to produce a certain level of return regardless of the markets. And there are tactical strategies and strategic strategies. For any investor’s personal goal(s), several of these, or a combination of these, might provide the necessary investment returns to get you there.

Raupp_Everyones_Unique_2.14.14_1Here’s where the emotions can come into play—if you don’t feel comfortable along the way, your emotions can take over the driver’s wheel, and your investor returns can fall short of your goal. In 2008-2009, many investors panicked, fled the markets, and decided to go to cash near the market bottom; but they missed much of the huge market rebound that followed. While in many cases the investors pre-recession strategy was sound and ultimately would have worked to reach their goals, their irrational decision during a period of volatility made it a tougher road.

Unfortunately, you don’t have the benefit of rolling a few gutter balls while you’re trying to find the right portfolio. That’s why working with an expert to find an investment strategy that can get you to your goals, and that matches your personality and risk profile, is vital to success.

Good bowlers show up at the alley with their own fitted ball and rightly-sized shoes. Good investors put their assets in a strategy fitted to their goals.

What About The Correction?

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

Over the holidays, I spent a lot of time with some family members that I don’t often get to see. We got together, had a little too much to eat and drink, and gave each other updates on what’s happening in our lives. Between the updates on kids, new careers, and new houses (no new spouses or kids this year), we never miss the opportunity to get some free advice from one another.

My two sisters are both in healthcare and handle all questions related to our aches and pains. My cousin the mechanic will venture out to the driveway and listen to the ping in your engine for the cost of getting him a beer. You get the idea.

My contribution is on the investment side, fielding questions about 529 plans, IRA distributions, 401(k) plans, etc. But the biggest question is always some version of “where is the market going?” This year’s edition, fueled by the huge returns in stocks in 2013 (and a good dose of CNBC), was “do you think we’re going to get a market correction?”

Hello, My Name is Free AdviceI suggested that when you look at how far the market has run and the high levels of investor sentiment right now—indicating that a lot of good news is priced into the market— I could easily see the market pulling back 5-10% on some unexpected bad news. The natural response from my family was, “What should I do?” “Nothing,” was my presumably blunt response.

My rationale is this: From a fundamental standpoint, the market looks good. Companies continue to grow earnings at a steady, albeit slow, rate. The market isn’t cheap, but it isn’t expensive either, and rarely does P/E compress without a recession. Speaking of the r-word, GDP growth continues to be sluggish, but it’s positive and expected to increase in 2014. Housing, the root cause of the last recession, continues to improve in spite of rising rates. And the Fed launched the previously-dreaded tapering of its quantitative easing without any market hiccup.

Depending on the attention span of my audience, all of that might boil down to simply saying, “We could get a correction, but if you’ve got at least 6-12 months, I think the market will be positive from here.”

Now, let’s go check out that leak on my car…

What is Investment Risk?

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

One of the go-to formulas of horror movies is to try to avert the audience’s (and character’s) attention away from the real risk. Someone hears a noise in a (supposedly) empty room, they walk in and see an open window. The unfortunate character starts focusing on why the window would be open, maybe even leans out the window and starts looking around. At some point, the character is satisfied that the open window is no longer a threat (whew!), closes the window, turns around, and BAM! You find out the real risk came in through the window and was hiding in the room. Now, the settings and characters change (why don’t we try having a group of sharks caught in a tornado?), but the formula remains the same.

Similarly, investors can sometimes get caught focusing on certain risks, while it’s often the ones they’re not focused in on that cost them the most.

One of the most widely used ways that investors look at risk is the standard deviation of an investment. Harry Markowitz won the Nobel Prize largely on his work on Modern Portfolio Theory (MPT), which defines risk as standard deviation. The standard deviation gives you a basic measure of how volatile the return stream of an investment has been (or is expected to be), and is extremely useful in getting an understanding of what to expect in a normal environment.

11.22.13_Raupp_Whatisinvestmentrisk_2MPT took the concept of risk further in recognizing that the correlation of investments in a portfolio is also important, that the combination of investments with a low or negative correlation to one another can create an outcome where you can get a higher level of return for a given level of volatility. This enabled investors to create an “optimized portfolio,” which was the best possible mix of investments to maximize your return for a given level of risk.

The problem with this is that we don’t live in a normalized world, where return distributions are symmetrical and correlations between investments remain constant. 2007 and 2008 were shining examples of that. Quantitative strategies that had been effective in a “normal” environment collapsed when price moves that they had viewed as “once in a million year events” started occurring with regularity. Optimize all you want, but if you owned an investment vehicle backed by Lehman Brothers you probably didn’t have a good outcome, even if you were on the right side of the trade.  And not many people factored in the possibility of their money market fund breaking the buck, as happened to the Reserve Fund.

So, what’s the solution? Diversification. Inevitably you’ll find your investments adversely affected by some kind of risk; however, with proper diversification just part of your portfolio will be affected rather than the entire thing. But while the MPT concept of diversification starts you in the right direction, it doesn’t check all the nooks and crannies where danger might be lurking.

Thinking about how asset classes would react under different scenarios or events helps you to better protect your portfolio. Entering 2007 most investors would have thought commodities were good hedges against a stock market decline. Commodities had done very well in 2000-2002 when the tech bubble burst, and touted a negative correlation to stocks over most trailing periods, a huge consideration when optimizing a portfolio using MPT. But when a deep recession caused consumption and production to plummet, commodity prices dropped right along with stocks, leaving many investors scratching their heads. The credit crisis did that to nearly all asset classes with any level of risk associated with it, leaving the only winners investors in high quality bonds and a relatively obscure (at the time) strategy called managed futures.

11.22.13_Raupp_Whatisinvestmentrisk_1The lesson is clear. There are times when “normal” becomes abnormal and the way asset classes interact with one another changes. So while checking the open window in the empty room might be the right thing to do 99% of the time, it pays to be on the look-out for the monster in the closet.

Sentiment

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

In February 1637, tulip bulbs sold in Holland for as much as 4,000 guilders each, over 10x the amount a skilled craftsman would earn in a year.  Months later, many tulip traders found themselves holding bulbs worth just a fraction of what they had paid for.

As crazy as prices got, tulip mania actually started with good fundamentals. Tulips were a relatively new introduction to Europe, and the flower’s intense color made it a heavily-desired feature of upper-class gardens. Most desirable were the exotic-looking, multi-colored tulips, which was caused by a mosaic virus not identified until the 1970s and now called the “tulip-breaking virus.” At best, tulip bulbs weren’t easy to produce and those with the virus suffered even lower reproduction rates. In the beginning, what occurred in the tulip market was classic supply and demand—a highly sought-after item with limited supply increasing in price. In 1634, that started to change as 11.1.13_Raupp_Sentimentspeculators were attracted to the rising prices, and in late 1636 prices started to accelerate rapidly, to where even single-color tulips were attracting prices of over 100 guilders apiece. The Dutch created a futures market for tulips that enabled traders to purchase and trade contracts to buy bulbs at the end of the season. At the peak, tulips could be traded several times a day without any physical tulips actually being exchanged or either party ever having any intention of planting the bulbs.

Then in February 1637, buyers vanished. Some suspect an outbreak of the bubonic plague as the cause, some a change in demand caused by war in Europe. Any way you look at it, the sentiment for the future price of tulip bulbs took a big U-turn, leaving many investors ruined.[1]

11.1.13_Raupp_Sentiment_1History is full of similar episodes, where investor sentiment got to extreme levels and prices diverged meaningfully from the underlying fundamental value of something, be it stocks, real estate, currency, or even tulip bulbs. Most recently the dot-com bubble in the early 2000s and the housing bubble in 2008 proved that speculation is alive and well.

While periods of extreme sentiment are easy to identify in retrospect, they’re anything but obvious while you’re in them. And while extreme levels of sentiment usually result in big price reversals, more modest levels can mark periods when the market is overbought or oversold, often followed by a market pull-back or rally. Recently, Robert Shiller of Yale University won the Nobel Prize in Economics for his work on irrational markets.

11.1.13_Raupp_Sentiment_2So how can you gauge sentiment? Some of the more popular ones are the Consumer Confidence Index and the Michigan Consumer Sentiment Index, which both try to gauge consumer’s attitudes on a variety of things, including future spending, the business climate, and their level of optimism or pessimism. More direct, and generally more volatile, are the AAII Investor Sentiment Survey and the Wells Fargo/Gallup Investor and Retirement Optimism Index, which ask investors directly about their thoughts on investments. It doesn’t end there. Investors watch Closed-End Fund discounts, Put/Call ratios, even tracking the occurrence of certain words or phrases in the media. In addition, many firms create their own blend of surveys and indexes to best gauge the overall sentiment level.

Sentiment certainly isn’t the be-all, end-all for trading your portfolio. There’s a saying that is attributed to John Maynard Keynes, “The market can remain irrational longer than you can remain solvent.” When sentiment starts moving in one direction, it’s hard to say when the reversal will occur and what will cause it. But knowing where sentiment levels are at any given time can help you get a better understanding of what markets have been doing and what to expect going forward.


[1] Mackay, Charles (1841), Extraordinary Popular Delusions and the Madness of Crowds, London: Richard Bentley, archived from the original on March 31, 2008.

There’s a Reason It’s Cheap

Jeff RauppJeff Raupp, CFA, Senior Investment Manager

A few years ago when I was down the shore in New Jersey with my family, I decided it was time for my then nine- and six-year-old children to try one of my favorite childhood pastimes—boogie boarding. For those unfamiliar, a boogie board is a (very) poor-man’s version of a surf board; basically a short board that helps you ride waves either on your stomach or, if you’re really good, your knees. So we went to the store to buy a pair of boards and found a pretty wide price range— $10 for the 26-inch, all-foam board to $100+ for the 42-inch poly-something-or-other board with the hard-slick bottom. Being a bit of a value investor, and not knowing how much the kids would like riding waves, I went with something much closer to the bottom end of that range. To make a long story short, three hours later I found myself with a broken board (who knew a foam board couldn’t handle a 200+ lb dad demonstrating?), a broken ego, and a trip back to the store to purchase a new pair of boards—this time closer to the middle of the price range. A good lesson for the kids, but definitely a reinforced lesson for me, is often when something is cheap there’s a very good reason why.

8.22.13_Raupp_Cheap_1I’m reminded of this lesson when I look at global equity valuations, particularly those in Europe. Forward P/E ratios (stock price divided by the next 12 months of projected earnings) in most of the major Eurozone countries fall in the 10- to 12-times range, which is relatively cheap from a historical perspective. Compared to the U.S. at 14½ and other developed countries like Japan and Australia at close to 14, the region seems pretty attractive. Tack onto that that the Eurozone has just emerged from its longest recession ever, and the idea that markets are forward-looking, it would seem like a great opportunity to rotate assets into cheap markets as their economies are improving. And we’re seeing some of that in the third quarter, as the Europe-heavy MSCI EAFE index has outpaced the S&P 500 by about 3% quarter-to-date.

But, similar to low-priced boogie boards, buyers of European equities need to be aware of the risks that come with your “bargain” purchase. This past Tuesday, German finance minister, Wolfgang Schauble, admitted that there would need to be another Greek bailout next year even though they’ve been bailed out twice in the last four years and restructured (defaulted on) 25% of their debt in 2012. All told, about $500 billion has gone to support an economy with a 2013 GDP of about $250 billion, and it hasn’t been enough. And by the way, youth unemployment is approaching 60%, and 2013 has seen multiple protests and strikes over austerity measures.

8.22.13_Raupp_Cheap_2Beyond Greece, Portugal and Ireland are running national debts of over 120% of GDP and could need additional bailout money. Italy is operating with a divided government and a national debt of over 130% of GDP, and the Netherlands and Spain are still on the downward side of the housing bubble. Germany has been Europe’s economic powerhouse and has played an integral role in containing the debt issues on Europe’s southern periphery. But they’ve been grudging financiers, so much so that German chancellor Angela Merkel has gone to great lengths to avoid the topic of additional bailouts ahead of upcoming German elections.

Sometimes that bargain purchase works out. You get the right product on sale or you’re able to buy cheap markets when the negatives have already been baked into the price. But make sure you’re considering all the angles, or you could quickly end up back at the store.

Investment Insights Video: Responding to Rising Interest Rates

In May, Federal Reserve Chairman, Ben Bernanke, announced the possibility that they will begin tapering in the upcoming months. As that notion looms, so too does the prospective of rising interest rates.

We sat down with Bill Miller, Chief Investment Officer, and Jeff Raupp, Senior Portfolio Manager to discuss how Brinker is prepared to respond to the upcoming policy changes.  In this installment of Investment Insights, Bill and Jeff will give financial advisors and investors a clearer understanding of the tools available to Brinker Capital and how our portfolios can manage the impending environment of rising interest rates.