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The investment odds don’t need to be stacked against you

This article was first published on New Age Alpha here.

Imagine you’re sitting, minding your own business, and your buddy, Louie, shoulders up to you and begins his sentence saying, “What are the odds…?” With such an introduction, his next words will almost certainly detail a plan with little chance of success. Whether it involves a sketchy business venture or his shot at a career in cricket, the implication is that the possibilities are not in his favour. Why is that? Why, when people speak about odds, does it always seem to carry a negative connotation? Perhaps it’s because we’ve been trained that way — by casinos, by bookies, by even life itself? When it comes to odds, humans seem to naturally assume the worst and conclude there’s nothing they can do about it. Because the truth is, there’s a better way.

The use of the term, “odds,” dates back to the 1500s with one of its first, and most famous, usages occurring in Shakespeare’s Henry IV, Part 2: Act 5. Generally regarded at the time as an expression signifying, “unequal things, matters, or conditions,” many believe it evolved from the more numerically focused concept for, “things that don’t come out even.” While the connotation of the word is different now, it’s important to remember this etymology. Because, when investing or gambling, the odds will never be equal. So, it’s up to you to shift them in your favour.

How can one do this? Approach the endeavour differently. When gambling, for example, the outcome is often a bifurcated event—either the ball lands on black or red, and you either win or lose. Investing is a different beast, however. Here, there are chances to impact the odds. For example, diversification forms a key part of risk management for many investors. They believe that spreading one’s investments across similar stocks or industries can avoid a disastrous, unexpected event in any single company. It is important, no doubt. But true risk management doesn’t end there since this approach does nothing to mitigate the risk of human behaviour bias. We believe this is where investors have a unique opportunity to alter the odds.

Think of it like the classic European roulette wheel. If a person believes that the ball will land on black—a faulty assumption, for many reasons, that person can spread their chips across all the 18 black outcomes. They think this crude diversification will help since, in the abstract, it would make their odds 50-50 versus the red slots. However, while the wheel is composed of an equal number of these black and red slots, it also has one outlier in the green slot bearing a zero (“0”). It doesn’t seem like much, but that single slot means the long-term distinction between winning and losing. It’s an edge to ‘The House’ of a mere 2.7%. Only 270 basis points, in financial-speak. Yet that’s enough over the long haul to ensure casinos can continue to light the lights, comp the free drinks and employ hundreds of thousands. Think about that. That crucial 270 bp detail is the foundation of the notion, “’The House always wins.”

But what if we told you there was a way to metaphorically carve out your own 38th slot on the wheel?

Most gamblers and investors would likely kill for the ability to alter the odds in such a way. It would offer the chance to mitigate risk without impacting potential upside—in essence, an utterly new type of diversification. How can investors apply this approach to their portfolio? We believe the best way to mitigate the risk of human behaviour is to avoid the losers. In our opinion, most investors think in terms of picking winners—but this means investors are forced to predict the future that, by definition, is unknowable. This is akin to guessing and it plays directly into the hands of oddsmakers such as sports bookies or casinos. They’ve already mastered the art of odds-making; they simply sit back and allow others to take on that risk. By, instead, avoiding the losers, you’re playing the role of the casino or bookie.

This is why at Global and Local Asset Management we employ New Age Alpha’s Avoid the Human Factor solution. New Age Alpha has built a solution suite using probabilities that aims to deliberately avoid the losers. By doing so, we have divorced ourselves from traditional portfolio management ideas and, instead, drawn on the actuarial principles of the insurance industry.

Below, we present the Up and Down Capture Rates as of May 31, 2021 of the U.S. Large-Cap Leading 50 Index and the U.S. Small-Cap Leading 50 Index that are benchmarked against the S&P 500 and the S&P SmallCap 600 Index, respectively, which are generally recognized as primary representatives of the U.S. equities markets. A high Up Capture indicates that the Index beat the benchmark during periods when the market, overall, was notching higher. Conversely, when the market went down, a low Down Capture indicates that the Index avoided many of those companies in the benchmark that went down.

While we believe the Up Capture across each Index and time period is noteworthy, in our opinion, the Down Capture truly stands out. Over the last year buffeted by uniquely unusual events such as the pandemic, market stimulus and the rise of the retail traders, New Age Alpha’s Indexes weathered the down moments with Down Captures entire quartiles lower than the respective Indices’ value of 100. Unto itself, we believe that’s an impressive accomplishment. But this belies the most important aspect of the offerings: this performance was achieved with very little overlap in the largest names of the respective benchmark. By using an actuarial-based approach to focus solely on known information, New Age Alpha’s Indexes avoided those stocks most impacted by human behaviour bias and utilized the same universe to provide different exposures. In the process, a differentiated source of return was created that can be used to complement any of the major benchmarks.

Source: New Age Alpha, Morningstar Direct

Gambling and investing are entirely different activities. Any proper investor knows that. But one thing both activities share is their reliance on odds. Seemingly, people refer to ‘odds’ when they’re stacked against them—as in the case of casinos or sports bookies—but they don’t use the term as much in relation to their investment portfolios. Perhaps they should. If all it takes is a new investment option such as these, why wouldn’t they want less correlation with the overall market while potentially producing the same or better performance?

Matthew Waterman is an investment writer at New Age Alpha.

About Us

At Global and Local Asset Management we firmly believe in stripping out all vague and ambiguous information from the investment process. Which is why we use New Age Alpha’s developed system called Avoid the Human Factor (H-Factor). The H-Factor measures the probability a company will fail to deliver the growth implied by the stock price. This risk is caused by investors interpreting vague and ambiguous information and impounding it into a stock’s price in a systematically incorrect way. The lower the Human Factor, the more likely vague and ambiguous information has NOT been priced into the stock. The H-Factor System is a free comprehensive portfolio tool that enables investors to apply our Human Factor metric to over 6 000 stocks, ETFs, global indexes, and their own portfolios.

New Age Alpha is a global leader in building actuarial-based asset management solutions that aim to protect investor portfolios against this idiosyncratic risk caused by human behaviour. Investors are unaware of this risk that leads to loss, cannot be diversified away, and don’t get rewarded for taking it. Unlike firm-specific risk, which can often be diversified away, this risk affects stock prices specifically and we believe is caused by human behaviour. Through New Age Alpha’s research, they have identified a differentiated source of alpha that is uncorrelated with traditional risk factors and managers, and as the foundation to their investment approach, they have built a range of actuarial-based asset management solutions that aim to mitigate the risk of human behaviour.

If you would like to know more about how the Human-Factor score tool works and how we “Avoid the Losers”, then please contact us at Global & Local Asset Management.

Disclosures

Global & Local Investment Advisors (Pty) Ltd is a registered financial services provider in terms of the Financial Advisors and Intermediary Services Act (FAIS). Global & Local Investment Advisors (Pty) Ltd holds FSP license number 43286.

Global & Local Asset Management (Pty) Ltd. Reg. Number: 2018/580284/07

Global & Local Asset Management is an authorised juristic representative of Global & Local Investment Advisors (PTY) Ltd FSCA License Number: 43286

Any investment performance figures quoted herein are for illustrative purposes only and should not be construed as investment advice.

Investment advice can be provided by Global & local Investment Advisors (Pty) Ltd but only after an analysis has been conducted of the investor’s current financial circumstances and investment portfolio, only then will a recommendation be provided based on that investor’s own circumstances by Global & Local Investment Advisors (Pty) Ltd.

New Age Alpha refers to the New Age Alpha separate but affiliated entities, generally, rather than to one particular entity. These entities are New Age Alpha LLC, New Age Alpha Advisors, LLC (“New Age Alpha Advisors”) and New Age Tau, LLC.

Investment advice is offered through New Age Alpha Advisors, LLC a wholly-owned subsidiary of New Age Alpha LLC.

New Age Alpha Advisors is an investment advisor registered with the U.S. Securities and Exchange Commission. New Age Alpha Advisors, located in the State of New York, only transacts business in those states in which it is properly registered or qualifies for an applicable exemption or exclusion from such state’s registration requirements.

Past performance is not indicative of future results. Current and future results may be lower or higher than those shown. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended and/or purchased by New Age Alpha), or an Index, product, or strategy made reference to directly or indirectly in this firm overview, will be profitable or equal to corresponding indicated performance levels. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Historical performance results for investment indexes and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. Returns for one year or less are not annualised but calculated as cumulative returns.

No client or prospective client should assume that any information presented in this firm overview serves as the receipt of, or a substitute for, personalized individual advice from New Age Alpha or any other investment professional. Any charts, graphs or tables used in this firm overview are for illustrative purposes only and should not be construed as providing investment advice. Information contained herein does not reflect the actual performance of New Age Alpha’s products or portfolios. All research and data is simulated and should not be considered indicative of the skill of New Age Alpha. The research data presented has been calculated by applying each Index strategy backwards in time and is not a contemporaneous record of actual assets managed by New Age Alpha.

All New Age Alpha trademarks are owned by New Age Alpha LLC. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC (SPFS). All other company or product names mentioned herein, including S&P®, are the property of their respective owners and should not be deemed to be an endorsement of any New Age Alpha product or strategy. This firm overview is limited to providing general information about New Age Alpha and its investment advisory services. It is for informational purposes only and should not be construed by a client or a prospective client as a solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice. New Age Alpha’s specific advice is given only within the context of its contractual agreements with each client. Investment advice may only be rendered after the delivery of Form ADV Part 2 (an investment advisor’s disclosure document) and the execution of an investment agreement by the client and New Age Alpha. New Age Alpha’s Form ADV Part 2 and descriptions and summary annual reports or its composites are available upon request.

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Mauro Forlin

Global & Local Asset Management

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