Exchange traded fund investors who are looking for a steady long-term investment strategy to diversify their portfolios can consider an approach that seeks to do exactly that: Winning by not losing.
In the recent webcast, Excellence Without Emotion: A Better Investment Process, New Age Alpha’s co-founder and CIO Julian Koski and senior portfolio manager Andy Kern, PhD, highlighted the success story of the Oakland A’s, or what some may know as Moneyball — investors should avoid sexy and expensive superstars and focus more on the best on-base percentages that can help reduce the randomness of outcomes.
Specifically, the strategists argued that investors lose money when a stock is overpriced because market information is not perfect, so humans tend to impound vague and ambiguous information into stock prices. Consequently, companies are at risk of being unable to deliver the growth implied by their stock prices.
Over the long-term, avoiding losers can generate improved alpha and enhanced risk-adjusted returns. For instance, since 2002, a portfolio of low human factor quintile investments generated annualized returns of 14.7% with a Sharpe Ratio of 0.86. In comparison, a portfolio of high human factor quintile investments showed an annualized return of 10.7% with a Sharpe Ratio of 0.49.
The human factor identifies priced risks like Fama-French, beta, style, size, momentum, other modeled risks, unexplained idiosyncratic risks, and explained idiosyncratic risks.
This act of avoiding losers also provides an uncorrelated source of returns. The human factor has no more than a 0.43 correlation in either direction with any of the nine common factors, with a high of +0.36 correlation to volatility and a low of -0.43 correlation to momentum and value. After adjusting for all nine factors, the human factor returned 0.18% per month in alpha, and the combination of all nine factors only explained 39% of the return of the human factor.
Investors who are interested in avoiding the losers can look to New Age Alpha’s latest ETF offerings, including the AVDR US LargeCap Leading ETF (CBOE: AVDR) and the AVDR US LargeCap ESG ETF (CBOE: AVDG). These strategies offer an actuarial approach with an uncorrelated source of return.
Starting with a known investment universe, the S&P 500, AVDR identifies and removes the 450 companies with the highest human factor score to create a portfolio of 50 stocks with the lowest human factor.
Similar to AVDR, AVDG aims to outperform by avoiding low-rated ESG companies that the firm believes are most likely to fail to deliver the growth implied by their stock prices. Starting with a known investment universe, the Refinitiv U.S. Total Return Index, AVDG applies negative screening to remove all but the highest-rated ESG companies and stocks with the lowest human factor to create a portfolio of 50 highly-rated ESG stocks that provide the potential to outperform.
Financial advisors who are interested in learning more about the investment methodology can watch the webcast on demand here.