By Julian Koski, CIO and Co-Founder at New Age Alpha
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 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 they really don’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 did, 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:
| Group/Investment | Ticker | 1 -Year Excess Return (vs. S&P 500 Index as of 8/31/21) |
3-Year Excess Return (Annualized vs. S&P 500 Index as of 8/31/21) |
5-Year Excess Return (Annualized vs. S&P 500 Index as of 8/31/21) |
10-Year Excess Return (Annualized vs. S&P 500 Index as of 8/31/21) |
| SPDR® S&P 500 ETF Trust | SPY | -0.13% | -0.13% | -0.13% | -0.13% |
| iShares Core S&P 500 ETF | IVV | -0.04% | -0.04% | -0.04% | -0.06% |
| Vanguard Total Stock Market ETF | VTI | 2.19% | -0.17% | -0.03% | -0.14% |
| Vanguard S&P 500 ETF | VOO | -0.02% | -0.03% | -0.04% | -0.04% |
| Invesco QQQ Trust | QQQ | -1.84% | 9.60% | 9.69% | 6.19% |
| Vanguard Growth ETF | VUG | -2.24% | 7.13% | 5.64% | 2.69% |
| Vanguard Value ETF | VTV | 3.76% | -6.51% | -5.07% | -2.65% |
| iShares Russell 1000 Growth ETF | IWF | -2.87% | 6.28% | 6.10% | 2.88% |
| Vanguard Dividend Appreciation ETF | VIG | -4.78% | -1.87% | -2.02% | -2.01% |
| iShares Russell 1000 Value ETF | IWD | 5.01% | -6.79% | -6.52% | -3.52% |
| U.S. Large-Cap Leading 50 Index TR | – | 2.65% | 3.85% | 5.95% | 4.69% |
Source: Morningstar Direct, New Age Alpha