If one thing in life is true, it’s that what you don’t know WILL hurt you. Just ask that rube who lost $20 playing Three-card Monte…or that fly that got tricked into landing in a Venus Fly Trap. Everywhere, there are pitfalls lying in wait for the uninformed and this is no less true in the investment world. The hazard that damages people the worst, however, involves the exact amount of information that they know. Because the difference between what one knows and what one thinks they know is vast and false assumptions are often worse than outright ignorance.
Head Fakes and Fake Spikes
One of the best examples of false assumptions occurred one Sunday afternoon on the football gridiron. In a tight race to lead the AFC East, the Jets were up 24-21 on the Dolphins with 38 seconds left. Miami’s quarterback, Dan Marino, completed a pass that took them to the seven-yard line and his fellow Dolphins raced to the line of scrimmage to get ready to spike the ball—a tactic in football where the QB deliberately throws the ball at the ground. While it counts as an incompletion, it also stops the clock. This means it also acts as an improvised timeout and it’s a common practice at the end of close games.
Except Marino didn’t actually spike the ball. With a nod to his receiver, Mark Ingram, he and the Dolphins acted as if they were going to spike it…shouting and gyrating as if to save precious seconds. Meanwhile, the Jets lazed to the line of scrimmage, showing no urgency. Everything the Jets had been conditioned to expect in the football world told them that the Dolphins were spiking the ball. In the words of announcer, Paul Maguire, when referring to the Jets, “They stopped…they all stopped!” And Marino proceeded to fire a bullet to a barely-covered Ingram in the end zone to win the game.
How does this impact your investment portfolio? The insidious power of false assumptions. It’s comparatively easy for a person to admit they don’t know something. Far more dangerous is the assumption that one knows something when one really doesn’t. The Jets assumed they knew what Marino would do next. They were wrong. And they lost.
“Beware of false knowledge; it is more dangerous than ignorance.” – George Bernard Shaw
In the investment world, some analysts have attempted to put an objective measure on these false assumptions via the Citi Economic Surprise Indices (CESI). These are indexes designed to measure whether economic data for a given country is alternately beating or missing expectations. Many times, commentators have used the Index to gauge the strength of an economy, and, in fact, some have used a negative reading to imply that the economy might be headed for recession. But this is another example of a false assumption that is more dangerous than outright ignorance.
The tricky part here is the denominator in the metric. The CESI tracks economic data relative to expectations—rising when the data exceeds economists' consensus estimates and falling when it doesn’t. But what if these economists are simply wrong? Investors may be reading how the Citi Economic Surprise Indices has turned negative and decide that’s a reflection of the economy overall when, in truth, it’s merely a reflection of peoples’ expectations. That’s a huge difference. In fact, the indices were constructed more for FX Trading than to serve as a reading of the overall market. Citibank, the index’s creator, readily admits this. But—human behavior being it what it is—this hasn’t stopped prognosticators from forming opinions based on this false assumption.
Keep Your Head in the Game
At New Age Alpha, our primary investment goal is the avoidance of human behavior. This includes avoiding false assumptions and any other bias that might cause securities to be mispriced. We believe that humans, by their very nature, interpret vague and ambiguous information incorrectly and impound it into a stock’s price in a systematically incorrect way. To mitigate this risk, we’ve applied an actuarial-based approach to asset management and developed a proprietary metric to help calculate the probability a company is overpriced or underpriced. It’s called the Human Factor and it calculates this probability solely based on the company’s stock price and known financial information. We don’t rely on false assumptions like the Jets or misuse metrics that gauge opinions. We seek only to answer the question: What is the probability the company will fail to deliver the growth implied by its stock price?
The results? We believe we’ve created a new source of alpha by building a portfolio consisting of names that are differentiated from the top names in the major indexes. By avoiding the losers, rather than attempting to pick winners, our U.S. Leading 50 Index has beaten its benchmark, the S&P 500 TR Index, without resorting to the often market-timed constraints of a sector or factor focus. Below we compare our Index’s performance to the ten largest U.S. Large-Cap ETFs by AUM as defined by Morningstar Category as of 8/31/21:
New Age Alpha is ushering in a new age of asset management by applying an actuarial-based approach to investment portfolios. Utilizing these principles built by the insurance industry, we construct portfolio solutions, indexes, and tools that aim to identify and avoid a mispricing risk caused by investor behavior. Embedding well-established principles of probability theory in our investment methodology, we construct solutions that aim to avoid overpriced stocks in a portfolio—losers. We combine the alpha potential of active management with the advantages of rules-based investing to build differentiated equity, fixed income and ESG-themed portfolios that drive long-term outperformance.
New Age Alpha refers to the New Age Alpha separate but affiliated entities, generally, rather than to one particular entity. These entities are New Age Alpha LLC and New Age Alpha Advisors, LLC (“New Age Alpha Advisors”). Investment advice is offered through New Age Alpha Advisors, LLC a wholly owned subsidiary of New Age Alpha LLC. New Age Alpha Advisors is an investment advisor registered with the U.S. Securities and Exchange Commission. New Age Alpha Advisors, located in the State of New York, only transacts business in those states in which it is properly registered or qualifies for an applicable exemption or exclusion from such state’s registration requirements.
This material should not be construed as an offer to sell or the solicitation of an offer to buy any security. It is not possible to invest directly in an index. We are not soliciting any action based on this material. It is for general information purposes only. To the extent that it includes references to securities, these references do not constitute a recommendation to buy, sell or hold such security, the information may not be current, and it should not be read to suggest that it is an endorsement of New Age Alpha or its products or strategies. There is no intention for New Age Alpha to include any securities referenced herein, if any, in its portfolios unless they become part of the established universe of eligible securities that are part of each specific investment strategy.
Past performance is not indicative of future results. Current and future results may be lower or higher than those shown. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended and/or purchased by New Age Alpha), or an Index, product, or a referenced strategy, either directly or indirectly, in this material, will be profitable or equal to corresponding indicated performance levels.
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