Being Right is the Enemy of Staying Right

 
 “Being right is the enemy of staying right because it leads you to forget the way the world works.” – Jason Zweig.

It is common as we age we become more comfortable and confident in the activities and behaviors that have brought us the most success, or perhaps the least amount of pain. If we believe we are doing well, or not experiencing any pain, it can reduce the incentive and the desire to explore other ideas, especially ideas conflicting with what has been working for you. By restricting ourselves to a narrow perspective is dangerous as an investor in a world where accelerated evolution is dismantling current logic.

Buddhism has a concept called beginner’s mind, which is an active openness to trying new things and studying new ideas, unburdened by past preconceptions, like a beginner would.  This could also be regarded as simply being curious.  If Buddha can’t convince you to keep trying new things, maybe appreciating the value of a curious mind might?

When you go to sleep at night do you believe the world, or more specifically your world, is as it should be? I haven’t had many nights where my world was in the order I’d like to have it.  As much as I like to be in control, believing I am is much like thinking that what I am doing is always the right thing.  Very naïve thinking.

Applying what is right to investing is usually a moving target, but applying some simple logic can give us a good set of rules to live by. Here are my Coles Notes.

There is a reason why more and more investors are attracted to Exchange Traded Funds (ETFs) as opposed to mutual funds. Over the long term, typically 5 to 10 years, many ETFs will outperform mutual funds in their respective asset classes. An example of this is the Canadian Equity Fund Vs. the S&P/TSX Composite Index ETF XIC.

An ETF is simply a replication of an index, and it has to track the index it is replicating very closely or it will get penalized by the regulators and possibly shut down. Here is link to better understand ETFs.

An index or an ETF is governed by a strict set of rules, which as it turns out is pretty hard to beat since few managers beat their benchmark indexes over longer time frames. Clearly, the answer as to what to do is simple. Follow a good set of rules that consistently beat the indexes. Not only will you beat indexes, but you will be in a league of your own so to speak.

So where do you get the rules and the proof the rules are as good as they say? That is a tougher question to answer.  Fortunately for you, if you are reading this, you can click this link to the performance page of the Tycuda Group and scroll through our portfolios that are in a league of their own. 

So why is an index hard to beat for most fund managers? Other than an index having no fees and most ETFs having very low fees the answer in my opinion is really simple.  It is the strict set of rules that makes it happen. But it is the variety of potential investments the rules are applied to that allows the good stuff to happen.

An index is not comprised of all the stocks that are available in the market, they are comprised of the stocks that are allowed into the index based on the rules of the index.  Many don’t make the grade.  Several times a year most indexes review all the stocks in their marketplace to see if there are any changes that need to be made to their basket. And therein lies the beauty of the process. 

This is where the “Beginner's Mind” takes over. The index may start fresh twice a year, where it does a review of all the potential stocks. And in this broad basket of stocks that gets reviewed, there can be some new names that may have not even existed before this review, or have been passed over for years because they didn’t meet the criteria until now.

In with the new and out with the old. The new stocks coming in may be new emerging industries, and the stocks being removed may have been companies that failed to evolve. The beauty and simplicity of an index are to be admired as its makeup will change with the times, whereas managers may be stuck in a rut, believing their own biases and missing the changes occurring in the world. The slower one is to adapt, likely the greater their performance suffers.

At the Tycuda Group we go one step further after establishing a set of rules that can outperform the market. We bring various strategies together to ensure a more stable consistent performance. Then we have to be ever attuned to the logic that a strategy within our basket may go out of favour.  This recently occurred in our Canadian Composite Strategy which holds four of our models.

In August, we transitioned from a long standing dependable large cap Canadian stock strategy to our ETF strategy.  We’d usually expect about a 40% outperformance from the stock strategy over the ETF, but given the strength of international markets (particularly the US), our Canadian Equities were lagging. The change represented about a 20% shift within the Composite strategy.

We could continue to believe based on historical evidence that we should just leave well enough alone. But the truth of the matter was simply too obvious to ignore. We love all of our strategies because they all do the job they were designed to do. Our individual strategies have a set of rules, very much like an index has a set of rules. So they will always reach their objective, which is to follow the rules. These rules have historically beaten the benchmark. We can’t promote that they will always beat their benchmarks, but rules that allow the better performing securities to be part of an evolving portfolio should have a better chance and opportunity to be ahead of the pack. But at different times, there is good reason to love certain strategies more than others. If we want to win at investing, the team with the best players on the field will get the job done.