My Top 4 Take-Aways From the Morningstar ETF Conference (Part 2)

Alpha is a sideshow; Never quit

Ben Johnson 20.10.2016
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Alpha Is a Sideshow

Jason Hsu, chairman and CEO of Rayliant Global Advisors and co-founder of Research Affiliates, is widely recognized as one of the pioneers of “smart beta.” Hsu began his conference presentation by retracing the benefits of this marriage between the positive attributes of active (an opportunity for, but by no means a guarantee of, outperformance) and passive (transparency, low costs) approaches to portfolio management. In its essence, Hsu argues that strategic beta is just “low-cost factor investing.”

While the democratization of low-cost factor investing has been a generally positive development for investors of all stripes, early indications are that this phenomenon is carrying with it some old baggage. Specifically, Hsu showed that “timing woe,” as he calls it, is everywhere. Hsu and his Research Affiliates colleagues documented this “woe” in a research paper that was first published last year.3

What they call woe Morningstar regulars will know as the “behavior gap” that my colleague and Morningstar FundInvestor editor Russ Kinnel has documented for years in his annual “Mind the Gap” study. Both studies lay bare a sometimes vast differential between the returns that funds experience (time-weighted returns) and those that investors, on average, experience (cash-flow-weighted returns). This gap is tantamount to a self-imposed behavioral cost, and it is every bit as present and persistent in low-cost factor funds as it is in high-priced active strategies.

With investors suffering these self-inflicted wounds, “alpha is a sideshow,” said Hsu. In other words, it hardly matters whether funds beat the market if investors keep beating themselves up.

My Take-Away:

Yes, yes, 1,000 times yes. We cannot pound on the behavior drum enough. But it seems as though no matter how loudly the drum beats, investors keep marching in the same direction, following one another over the cliff.

Is there any hope for us? Can we rewire our lizard brains? I’d argue no. Though we can try to trick ourselves.

Here are a few tips I’d offer:

(1) Don’t look at your portfolio too often.
(2) Keep a journal documenting your investment decisions. This will help you to learn from past mistakes and hopefully give you better odds of replicating past successes.
(3) Implement a self-enforced cooling-off period. Put 24 hours between the time that you make an investment decision and the time you spend executing that decision. This should help to keep emotion out of the process.

Never Quit

I had the honor and privilege of introducing this year’s luncheon keynote speaker, Rob O’Neill. Rob was a SEAL Team Six leader and is one of the most highly decorated combat veterans of our time—a true American hero. O’Neill’s mantra is “never quit.” For an hour and 15 minutes, Rob held our attention (not a fork dropped, not an email checked) with his stories from SEAL training and special operations.

The key lessons O’Neill shared during his talk were the importance of preparation, of controlling your emotions, and of never giving up. Per O’Neill, the best plan ceases to be the best plan as soon as it leaves the planning room. Faced with uncertainty, chaos, and extreme emotional stress, it is critical to keep one’s emotions in check. O’Neill said that our first instincts are typically our worst. Only countless hours of training and emotional discipline can help us overcome these instincts. Per O’Neill, panic breeds panic and calm breeds calm. The former is unproductive, and the latter will keep you on track. Above all else, O’Neill urged his audience to never quit.

My Take-Away:

O’Neill learned these lessons in the highest-stakes scenarios imaginable. But they’re every bit as relevant in the much lower-stakes setting of investing to reach your financial goals. Particularly relevant is the importance of controlling your emotions and remembering that your first instinct is typically your worst.


[1] Asness, C.S., Frazzini, A., Israel, R., & Moskowitz, T.J., 2015. “Fact, Fiction and Value Investing.” J. Portfolio Management, Vol. 42, No. 1, P. 34.
[2] Asness, C.S., Frazzini, A., Israel, R., & Moskowitz, T.J., 2014. “Fact, Fiction and Momentum Investing.” J. Portfolio Management, Vol. 40, No. 5, P. 75.
[3] Hsu, J., & Viswanathan, V., 2015. “Woe Betide the Value Investor.” Woe%20Betide%20the%20Value%20Investor.pdf

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Ben Johnson  Ben Johnson, CFA is the Director of Passive Fund Research with Morningstar.

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