Fri, 9 Sep 2016
Rayliant CIO Jason Hsu says investors should tune out the noise of short-term performance and focus on being more contrarian.
Russ Kinnel: Hello from the Morningstar ETF conference. I'm Russ Kinnel, and I'm joined today by Jason Hsu, who's chief investment officer of Rayliant Global. Thanks for joining us.
Jason Hsu: Thanks, Russ.
Kinnel: So today you're talking about timing of investments. What have you found?
Hsu: So what I found is that, first of all, we all time, even people who say they don't time, if you think about how they buy products, they're looking at recent performance and making a decision. In a way, they're timing based on recent performance. You look at investors who make firing and hiring decisions and you're looking at recent performance again, you're just using short-term performance to time managers. So we all time, unfortunately, what we found from the result is we all time very poorly.
Kinnel: Well that's disappointing, but not surprising. So what can we do about the timing? How are we getting the timing wrong?
Hsu: So I think to really understand why we're getting the timing wrong, it's useful to think about, how are we making decisions? For most financial advisors, their end clients, even very large institutions, the heuristic is to look at recent performance. And we try to say, "Oh, if the manager's been good the last three years, he must be really skilled. There's true alpha there." And so we want to give him more money. And of course the true can be argued for managers who underperform. But that's not actually what the data tells us. What the data tells us is, the manager's skill is almost indiscernible in a short run. Much of what you see over the last three years are these cyclical boom busts related to the style he's in, maybe some of the sectors he's overweighed at, most of that's noise in very short term, and they tend to wash out over time. Once you realize that's what's actually happening, you understand why these short-term performances are mean-reverting and you should at least ignore them, or you should actually try to take advantage of them in being more of a contrarian against recent short-term performance.
Kinnel: So if short-term performance is largely noise, then how can we tune that out and improve on our timing?
Hsu: So, once you realize that people time, and time poorly, it also means that you could do better, like almost being on the opposite of those poor timing traits. So let's think about, why are people timing poorly? They overextrapolate from the recent outperformance. And recent outperformance is another way of saying an asset class has done really, really well and has become expensive, or a particular factor exposure has done really, really well, has become expensive. And so instead of adding more money to it, by mistaking short-term revaluation as some kind of true alpha, you want to be a contrarian and almost take profits and take money away from what's done really well and become expensive and then move money into what's done poorly. Which usually isn't because the manager's no good, or the style will never work, it's just that in the short run, it's gotten cheaper and cheaper for purely noise reasons, and that's actually where you want to be. So if you do this, you know, a systematic rebalancing, or maybe do a little bit more, a systematic over-rebalancing, you could develop an edge certainly, over people who are more trend-chasing in how they make decisions.
Kinnel: And certainly rebalancing is an easy thing to do in most 401(k)s now, you can even just check a box online that says, "Rebalance yearly" or different time periods available. So that's a really easy way to do it. And if it's in a 401(k) of course, there aren't even tax consequences. But you're suggesting you could even go another step further and even add a little more to the worst-performing investments in your portfolio, take a little more away from the strongest performers.
Hsu: That's absolutely true, and like you say, within a tax-advantaged account, the benefit of rebalancing is phenomenal because it doesn't have the tax consequence associated with it. I've even seen research, where careful and infrequent rebalance is still a lot better even in the face of some tax consequences. And in fact, the joke goes that in a 401(k), the best strategy is to actually set this rebalancing scheme and then just forget your password and never touch it again. Because I can bet you anyone who gets a little too active in managing their 401(k) would tend to log in frequently and move in and out of funds in exactly the wrong way.
Kinnel: Well Jason, thank you so much for coming by.
Hsu: Thank you for having me.