Amid a world of constant change, we seek to capitalize on evolving investment opportunities using a process that is objective, systematic, and disciplined.
You Can’t Model the Newsflow
Seeing a procession of eye-catching headlines on an almost daily basis brings to mind a saying popular among quantitative equity portfolio managers: You can’t model the newsflow. Indeed, who could have foreseen the wave of democratic change sweeping the Middle East, wiping away decades-old dictatorships and power relationships? Or the extent of the European sovereign debt crisis, that had financial markets seriously contemplating the possibility that a European Union member country would default on its debt?
Volatility Is the Norm
In just the last decade or so we have endured two wars, the Credit Crisis, the bursting of the housing and Internet stock bubbles, the September 11 tragedy, and the meltdown of hedge fund Long- Term Capital Management, among other notable events. What is striking about this is that the market volatility of recent years—without diminishing these truly remarkable events—when viewed in this context looks less the exception to the rule and more the investing norm.
When looked at in this way, it is clear that change and volatility are the only constants in the investment world. But change creates investment opportunities. And while you can’t model the newsflow, you can model investor behavior and employ a disciplined, data-driven process to capitalize on the resulting inefficiencies. Certainly, we know from experience and reams of academic research that emotions in times of crisis can lead to poor financial decision making. One need only think of investors swept along by the emotions of fear and greed buying Internet stocks in March 2000 or selling financial stocks in late 2008 and early 2009.
Exploiting the Change Dynamic
It is precisely these behavioral anomalies that our process aims to systematically exploit. Note that every investor does not have to behave irrationally for these inefficiencies to exist, but it is manifestly true that the market as a whole is informationally inefficient. So rather than base investment decisions on vague financial headlines, we position our portfolios where we have certified, regular, investible data—at the company level. Indeed, these are among our core investment tenets:
- Behavioral biases lead investors to make predictable, irrational mistakes
- Removing human emotion improves consistency
- A proprietary, multi-factor approach systematically exploits behavioral mistakes
Here we should say a word about our multi-factor stock-ranking model. Our analysis indicates that it’s important to incorporate multiple factors in the stock selection decision because a broad, diversified approach enhances the consistency and predictability of our stock-ranking model. Finally, we use a risk-management process to ensure that the portfolios are diversified by sector, industry, and growth and value characteristics. These constraints help minimize unintended risks and maximize the active return coming from the stock-ranking model. And in a world where you cannot model the newsflow, being broadly diversified is the best way we know to reduce the risk from ever-changing headlines and refocus the risk-reward relationship on our individual security selection decisions.
The opinions expressed are those of Scott Wittman, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio.
For educational use only. This information is not intended to serve as investment advice.