Well 2013 is over and once again the phenomenon I call The CFA Paradox continues. I haven’t done an exhaustive audit, but I’m 99% sure that if you look at the performance of my stock selections before and after completing the CFA Program, on average I was a better stock-picker before I went through the program.
Here’s 2013, for my trading portfolio (a significant % of my net assets). Almost all of the portfolio was equally split at the start of the year between 20 companies. All equity, no funds or indexing.
There are a variety of explanations for the lag, apart from just needing 5-10 years to go by before being able to tell how you’re actually doing with any confidence.
One is that it’s unfair to compare my return to the S&P, since comparisons should be done on a risk-adjusted basis. Since my consulting work has me mostly making buy / sell recommendations on large, safer companies – that’s the universe I now pick from (to make sure I’m eating my own cooking). Yahoo Finance says the weighted average beta of the companies in my 2013 portfolio was 0.67. With the risk-free rate at 0%, this means my alpha was:
Not bad at all! Except the S&P was really my personal benchmark to beat. Ooops…
There’s another phenomenon that might also be at work. Pre-CFA, even though I would have told you at the time that I was doing value investing, I didn’t actually know how to read financial statements or analyze companies. My picks basically came from a value screening process (low P/E, low PEG, Magic Formula, etc.). I bought a diversified group of companies that appeared to be good and cheap, often without knowing what a lot of the companies even produced!
As I’ve learned lately, this can actually work in your favor. What often happens is that investors begin with using screens like these that have a history of delivering excess returns, only to later “graduate” to cherry-picking the best companies that come out of the screener as their analytical skills get more sophisticated. The thinking is, the screen provides a floor to your performance, and that by smartly throwing out the bad companies, you’ll do even better!
Unfortunately, the screen often provides a ceiling to performance instead. By cherry-picking, you stay away from the scary companies (loss aversion bias), which… is where the true bargains are! Many (or most) will do horribly, but a few will turn out to be real home runs and more than compensate. You just can’t tell ahead of time which ones they’ll be so you have to buy them all.
Ah the days of innocence, when I not only didn’t know what most of the companies I bought did – in many cases I didn’t even know the companies’ names! But high beta tailwinds and no loss aversion headwinds. If ignorance is bliss, ‘tis folly to be wise.