iQUANT understands the temptation to get caught up in the performance of individual selections within a strategy. However, it is crucial to shift our focus to the bigger picture – the strategy itself. A strategy's success should not be solely determined by the performance of its individual picks. In this blog post, we will explore the importance of focusing on a strategy and accepting both winning and losing selections as part of the process. We will use Berkshire Hathaway as an example to illustrate how even a highly successful company has experienced underperforming individual selections while continuing to provide superior long-term performance.
The Power of Strategy:
When evaluating an investment strategy, it is essential to recognize that individual stock selections may occasionally underperform. However, this does not necessarily imply that the overall strategy will underperform. A successful strategy is built on a well-defined and disciplined process that considers various factors and indicators. It is the cumulative effect of adhering to this process that generates consistent returns over the long haul.
Berkshire Hathaway: A Prime Example:
The legendary Warren Buffett's Berkshire Hathaway serves as a shining illustration of the significance of emphasizing the strategy over specific decisions. Berkshire Hathaway has invested in businesses over the years even though they fell short of expectations or faced difficulties. The $10 billion write-off of Precision Castparts is a prime illustration of a setback in Berkshire Hathaway's portfolio. The overall performance of Berkshire Hathaway has remained strong despite this sizable loss. This illustrates the durability of a sound strategy and the significance of concentrating on long-term outcomes rather than short-term stock performance.
Every Strategy Has Selected Losers:
A perfect investment strategy does not exist. In a typical year, 25–40% of S&P 500 stocks experience negative returns, according to historical data.
It is crucial to convey to clients that every investment strategy, no matter how succesfull, will have its fair share of losers. By examining the historical performance of any strategy, advisors can point out instances where winning selections coexist with losing selections. It is through consistent adherence to the strategy's process that the strategy as a whole achieves long-term outperformance.
The Pitfall of Manipulating Strategies:
The worst mistake an advisor can make is trying to manipulate a strategy by selectively removing losers or only retaining winners. This "window dressing" approach undermines the integrity of the strategy and introduces a behavioral bias that can be detrimental to long-term performance. It is important to educate clients on the potential dangers of such behavior and emphasize the value of staying committed to the strategy's process.
Addressing Client Concerns:
When clients express concern over specific losing selections, advisors should push back and reiterate the importance of focusing on the overall strategy. Using the example of Berkshire Hathaway, advisors can showcase how even successful investors face temporary setbacks but ultimately achieve long-term success. It is crucial to reassure clients by providing historical ranges of short-term returns and illustrating that their chosen strategy and/or portfolio remains well within its normal historical performance, despite isolated poor performance from a few individual stocks or ETFs.
The historical ranges of short-term returns can be found on iQUANT model factcards as well on the Portfolio Optimizer.
Conclusion:
As investment advisors, it is our responsibility to guide clients toward a deeper understanding of the power of strategy. By shifting the focus from individual selections to the overall process, we can help clients navigate the natural ebb and flow of investment performance. Remember, it is through disciplined adherence to a well-defined strategy that long-term success is achieved.