How to Succeed in Investing Without Really Trying

            Every now and then I hear someone claiming that active investing isn’t worth it or that actively managed funds generally don’t outperform the stock market as a whole.  They can’t justify charging X percent to manage your money.  The list of excuses goes on.  Things are even worse for individuals trying to manage their own money: too many numbers to crunch, not good enough infrastructure to compete with the banks, not enough time to actively manage a portfolio, and a whole laundry list of excuses. The conclusion invariably given is that one ought to invest his or her money in a total stock market index like SPY, VTSMX, etc and go on with their lives.

            I wouldn’t dream of saying that individuals have any absolute advantage over institutional investors, but I would contend that anyone can build a portfolio of individual stocks that outperforms the stock market. To that end, I spent about 45 minutes picking stocks without using any fundamental analysis, technical indicators, or any esoteric methodology, and was pleased with the results.  Below are my criteria (in bold) with rationale and tests.  As a disclaimer: dividends and taxes were not taken into consideration for the sake of simplicity.  Assuming a buy-and-hold strategy, and in light of the ultimate results, these are both inconsequential.

            First, just because we don’t do the math ourselves doesn’t mean we should disregard the math of others.  To start out with, I decided to draw upon four mutual funds that have five-star ratings from Morningstar (the people who do analysis): HSCSX, PMCPX, PRWCX, and FBIOX.  To ensure that strong performance wasn’t a recent phenomenon, I made sure that their fund managers had tenures of greater than five years.  Morningstar’s website lists the top 25 holdings of each fund and from the hundred in those four funds, I selected the following 17 stocks because they showed particularly strong performance this year: FISV, BDC, OLN, MANT, ACT, VRX, CCI, GILD, BIIB, BMRN, ICPT, ACAD, OPHT, ALKS, PCYC, UTHR, and GNMSF.  These I took to Google Finance to cull the best.  To qualify as “best”, the individual stock had to be publicly traded since the turn of the millennium (for testing later), have a price not substantially driven by trading volume (so that it wouldn’t be overly susceptible to a bad quarter or the best laid schemes of mice and Wall Street), and most importantly: outperform the S&P 500 Index in the standard time frames greater than one year.  So the winnowing began and the following seven stood out as winners: FISV, BDC, VRX, GILD, BIIB, BMRN, and PCYC.  After cherry-picking from the universe of over 5,000 stocks, we have a few to run with.

            To test, I made a paper portfolio in which 1,000 dollars was invested in all seven stocks on January 7^th, 2000.  To contrast: $7,000 was put in the total stock market, SPY.  The results even surprised me.  The SPY investment grew to around $10,100, an overall return of 44% in the past 15 years.  The paper portfolio of our selection grew to $1,687,797, an overall return of 24,112% over the same 15 years.  

Individual returns here:

FISV: 1764.39%

BDC: 126.57%

VRX: 515.35%

BIIB: 3237.1%

BMRN: 672.5%

PCYC: 316.36%

GILD: 162,147.8%

            It should jump out immediately that GILD gave the lion’s share of the performance.  Yet repeating the test without GILD, the weighted return of the portfolio is still over 1,100% ($73,135 from a $6,000 investment) and the worst performing individual security of the group, BDC, still nearly tripled the return of the market as a whole.

            The point of this exercise isn’t to suggest that one should adopt this strategy blindly or to ignore the fact that what we see looking back doesn’t assure what we’ll see going forward.  Individual stock picking is speculative by nature and the intelligent investor should keep that in mind without being afraid of it.  I simply wish to dispel the myth that investing is some kind of black box that is opaque to common people.  You don’t have to be good at math or have investment bank infrastructure to get started with stocks, just a healthy tolerance for risk and a dose of common sense.

Baller Example indeed

Performance without GILD

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Robinhood: A Shot across the Bow

            About ten months ago, I discovered a startup promising commission-free investing for the masses. Despite believing that too good to be true, I joined the waitlist at the 55^th spot.  Robinhood’s app released to the public yesterday and I couldn’t be more thrilled to be sticking it to the Jordan Belforts of the world. $10 per trade, while not prohibitively expensive, does force some digression in investing than might be prudent.  The app’s interface is gorgeous and streamlined but further commentary must be reserved until I’ve used it more.            

            Robinhood is just the latest in the larger democratization of finance trend.  The finance industry is notorious for being stuck in the past.  Despite advances in technology reshaping almost every facet of everyday life, finance relies on infrastructure invented during the Nixon administration (ACH being the archetype example).   In areas where it does excel technologically, banks keep the advantage to themselves.  Yet in a part of the world hell-bent on the disruption of any and all industries, Silicon Valley has taken it upon itself to shatter these bastions of a bygone era.             

            We saw Wealthfront in the last post, which is making algorithmic investing available to everyone, not just hedge funds and other groups with staffs of math PhDs.  As a counterpart to Edward Jones and other wealth advisors, SigFig delivers quantitatively sound investment picks in a manner understandable without needing a degree in finance.  If you happened to see GoPro’s S-1 filing, you’ll notice it was underwritten by the usual suspects, JP Morgan, Stifel, Citigroup, and the rest of the big banks.  Upon closer inspection, you’d notice that a young startup called Loyal3 was given 1.5% of the new shares to offer to the public at large for the IPO price.  Prior to Loyal3, a lay investor could only buy shares in the secondary market, typically for substantially more than the banks paid.  But now, the spread between IPO price and open market prices became accessible to everyone, or at least the lucky ones that snapped up those shares as soon as they were available.  (Twitter is an excellent example of this, with an IPO price of $26 but starting in the open market at over $41, a risk-free profit of more than $15 per share for the underwriting banks.) Slowly but surely, we are seeing the finance industry become more equitable, and more accessible, to the general population.     

            So niche startups like SigFig, Loyal3, Betterment, Quantopian, Self Lender, Stripe, and the rest wield technology to make finance easier for everyone.  Now we have Robinhood to add to this crew: a company competing with existing brokerages without charging any commission at all.  At the time of this writing, there are about 500,000 people on the waiting list. Wall Street ought to take this as a warning shot: old ways and manual processes will continue to fall in the wave of new technology.  On the other hand, they might surprise us all and welcome the competition.

"Nasdaq congratulates Robinhood on their launch" 

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Wealthfront: Investing for the Future

            After working for some time at a company which specializes in automating a touch-heavy component of the mutual fund business (intermediary compensation between brokers and their dealers), the things I had heard about the finance industry being behind the times suddenly became very real.  People from within the industry would confess to using infrastructure and technology from the 1970s yet had no plans to change it because their companies had enough money to continue being inefficient.  Having seen and heard other horror stories over my years of working in finance, it is incredibly clear that the majority of the industry is in major need of a makeover.  Yet it is slow in coming because incumbent leaders (financial advisory firms, investment banks, brokerages, etc) are monoliths that face neither competition nor the resource constraints that cause companies in other industries to innovate.  It is customers that are implicitly punished with high management fees, delays in transaction processing, and other inconveniences associated with failing to keep up with the zeitgeist.

            Luckily, in the 21^st century there has been a renewal of interest in the money management space which has led to all kinds of new tech startups like SigFig, Betterment, FutureAdvisor, PersonalCapital, Mint.com, Nutmeg in the UK, etc have been pouring immense energy and resources to pick up the slack with the ultimate goal of making it easier for non-finance people to enjoy transparency in knowing where their money is going and how it is performing better than it would be if it sat in a bank account or some other investment service.

            It is in this context that Wealthfront comes in.  The cause of making investing better for the people is a noble one and they have picked up a lot of publicity lately for doing just that (and also for closing a massive round of new funding).  Like many investment services, Wealthfront automates the complex process of finding a perfectly balanced portfolio.  Yet what makes them unique is the low management fees (and no commissions) which allow the service to be utilized by the general public. All of the sudden, esoteric investment strategies, daily rebalancing, tax-loss harvesting, and other features previously only available to a lucky few are at the fingertips of anyone who cares to sign up. 

            People have noticed.  Wealthfront’s massively disruptive business has garnered them over a billion dollars of assets under management in just two and a half years.  It will be interesting to see if traditional finance institutions take notice enough to alter their own businesses to keep up with the times.  It seems unlikely, but in the face of such new technology from Wealthfront and their peers, it might be hard to stay relevant for the generations of investors going forward.  I’ve always enjoyed helping friends get started with investing and offering specific guidance with which securities to pick.  Yet after reading about the automated investing industry, I think my direction for them will be much more succinct going forward. 

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Mark Cuban on a Great Pitch

            I recently read an article on TechCrunch about the four broad components of a good venture capital pitch according to Mark Cuban.  It is a good thought exercise for any startup, however, regardless of if or where it is in the process of fundraising because developed thoughts on each point are crucial parts of the nascent company's soul searching process.  These come in the form of answering four questions: what is your core competency? Why are you great? How will you scale? How is your idea protectable?  The first two relate to business and the latter two relate to product.

            The business questions are Sun Tzu repackaged for the 21^st century. “If you know the enemy and know yourself, you need not fear the result of a hundred battles…If you know neither the enemy nor yourself, you will succumb in every battle.”  It is of paramount importance that a company understand itself internally as well as externally as it is oriented in some market space.  The core competency question asks what you’re the best at and the question of “greatness” compares you to your competitors.  How are you better than other players in the space?

            The product questions relate to what comes out of your business.  Once the idea is executed, how difficult will it be to reach 10,000 people, 10 million people, a hundred million, and so on?  Is the product touch-heavy enough that employee-count will have to grow dramatically to accommodate an increased user base (such as insurance) or is it fairly self-service where most of the interaction is done independently by the customer (such as Pinterest)?  In this case, there is not a right or wrong answer since some products require more company involvement by nature than others.  Yet it is still important for a growing company to understand and convey the scaling situation to be adequately prepared ahead of time.  The question of being protectable is straightforward.  Barring instances where the first-mover advantage in highly capital intensive industries seals dominance (utilities, natural resource extraction, etc) there are always copycats out there that will try to capture market share when they identify good ideas.  Since protection is vital, patents are so important.  Beyond that, it is important for a company to be its own biggest competitor.  If a company does not innovate itself, someone else will innovate it to obsolescence.

            In my own experience with researching and writing investment memos, absent answers to any of these questions means it will be sent back for revision.  Yet once they are answered, everyone involved in the investment process will have a clearer idea of what the company in question is about and be able to make an informed decision from there. 

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Impact Investing As It Hits

            If you asked me a couple years ago what I thought of “double-bottom line” investing, I might have half-jokingly guessed you meant only considering net income, a reference to the peculiar formatting of that item on it's namesake statement.  Yet since working at Kiva for the past few months, I’ve come to appreciate more the merit of taking ideology and other intangibles into consideration when investing as opposed to merely seeking the highest monetary return.

            At Kiva, we often use terms like “risk-tolerant capital” or “patient capital” in conversation to describe the liquidity that runs through our pipes.  It has been unique, coming from a traditional finance background, where cash rules everything around me, to see the inner workings of a finance firm that facilitates lending money at zero interest.  What inspires people to do this?  Having been part of the organization for some time, I see the return first-hand.  Conscientious citizens given the opportunity to put their money where their mouths are will seize it and give nearly 1.5 million borrowers not a hand out, but a hand up: a chance to build themselves out of poverty. 

            The vast majority of investors, however, do not have the luxury of allocating their money simply based on good feelings.  Happily, impact investing has become an entire field with methodologies and funds that emphasize values without having to compromise financial return.  By looking at how internal and external stakeholders are affected by a business’ operation, an investor can decide whether holding them in a portfolio would be consistent with his or her values.  The commonly used metrics are summarized by a research paradigm called ESG analysis: environmental, social, and governmental measures.  

            According to MSCI and Pax World (providers of research and funds, respectively) environmental measures include carbon emissions, carbon footprint, energy efficiency, water stress, raw material sourcing, toxic emissions and waste, electronic waste, as well as opportunities in clean tech, green building, and renewable energy.  Social measures include labor management, human capital development, opportunities in health and nutrition, chemical safety, privacy and data security, and access to healthcare, among others.  Governance measures include levels of corruption, anti-competitive practices, fraud, etc.  To make an investment decision, the interested party chooses metrics relevant to the company being evaluated and draws a conclusion based on the findings.

            This kind of evaluation is esceedingly difficult for the individual investor who does not have the capacity to do this research independently and would find a subscription to research services prohibitively expensive for his or her needs.  Thankfully a lot of mutual funds and ETFs have sprung up in the past few years that invest according to ESG principles, though finding one that consistently outperforms the S&P 500 benchmark remains a unicorn hunt.  I may have some rebalancing to do ahead of Q3 dividends.  If this internship has taught me anything, it’s that the highest payouts may not be taxable. 

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International Waterways

People!

My senior thesis for economics is finished and published on the website. A couple of you have asked to read it and now it's here.  The topic is international rivers, the Nile and Mekong in particular, but the concept is common-pool resources.  CPRs are a variety of resources whose usage is shared amongst several parties.  The subject becomes complicated because the repercussions of certain actions or usage do not fall on the perpetrators of the action in the first place.  Rivers are a classic example because users upstream, whether for agriculture, fishing, or otherwise, end up impacting the outcomes of users downstream.  Over the course of time, stakeholders have sought to find ways to reconcile differences using economics, politics, biology, ecology, etc. and that is the matter at hand here.  The document can be found in the Writing Samples page as well as in the link below.  I hope you enjoy reading it as much as I enjoyed writing it.

The Curious Task of Shared Goods: International Waterways and their Treatment as Archetypal Common-Pool Resources

Acknowledgements:
Kristi Ellis, Morningstar Academy
Dr. Michael Rizzo, University of Rochester
Dr. Stephen L.S. Smith, Gordon College

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