Should You Keep Investing in What’s Winning Now? | Erik Averill, Justin Dyer | AWM Insights #60
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Episode Summary
Investment returns continue to soar higher across the world in both the public and private markets.
Should your future investments go into what has been doing the best recently?
While this seems like a prudent approach, the famous disclosure, “Past performance does not guarantee future results” that is plastered everywhere offers a strong warning.
Listen in as we answer how the current performance should impact your future decisions and how to Invest Like a Pro.
What’s Happening In The Markets
US Gross Domestic Product (GDP) jumped 6.4% in the quarter ending March. We now sit 1% below pre-pandemic levels after adjusting for inflation (I.e Real GDP)
Biden reaches 100 days in office milestone
Fed met last week (1 of 8 policy meetings set for the year) - left monetary policy unchanged
Stay Connected
AWM Capital: IG | LinkedIn | Facebook | AWMCap.com
Justin Dyer: LinkedIn
+ Read the Transcript
Erik Averill (00:00):
Hey, everyone. Welcome back to another episode of AWM Insights. It's your power three, two CPWAs and a CFA, we are Eric, Brandon and Justin. And at AWM we are a community of athletes, founders, and investors on a journey to be the best at what we do. And we believe you deserve the same when it comes to your wealth. So each week we cut through the noise of what Wall Street is selling you to bring you the knowledge, skills, and access to invest like a pro. And so today we're going to tackle the topic of resisting chasing past performance. But before we do that, as we do every week, let's jump into a few of the big new stories around the markets. And so first from the sports world, Endeavor goes public. And for our audience that is not familiar with Endeavor, they are one of the largest talent agencies in the world. They own properties like the UFC.
Erik Averill (01:01):
And it's an interesting story because two years ago, they attempted an IPO that completely failed. And now they obviously have gone public and really talking about the headwinds of all of the importance of sports going forward in that they believe so much of sports through the pandemic showed that it really is a Teflon when it comes to tough headwinds. And so very interesting story out of Endeavor.
Erik Averill (01:34):
On the gross domestic product front, we actually have seen 6.4% in the quarter ending March. We now only sit 1% below pre pandemic levels after adjusting for inflation. So just wild once again, to see how far we've come in a quick year post pandemic. And then crazy to think, President Joe Biden has reached a hundred days in the office. It felt like the election was just a few weeks ago, but here we are a hundred days into his presidency. And then in addition, the Fed met last week, they left the monetary policy completely unchanged. That was the first of eight scheduled meetings for the year. And something we're going to do a little different on this show is before we get into this topic, Justin's going to bring us up to speed. What exactly has been going on in the markets from a return standpoint year to date?
Justin Dyer (02:35):
Yeah, so I'll talk a little bit about a couple of different indices here or indexes and you guys will commonly hear some of these, I'll try and put a little bit of color around what is what, what the actual index is trying to measure. And let's start with potentially the question, rhetorical question that, what do we think is outperforming the most year to date? And I'm guessing a lot of people think tech, well guess what tech has not performed, it's performed well, but it has not been the top performer year to date. And I'm looking at tech as measured by the NASDAQ. That's a broad based index. It's primarily weighted towards tech companies. It's not inclusive, all inclusive of tech companies, something to keep in mind that is up just about 8% year to date as we're recording, as of when we're recording this, but the S&P 500, which is a much broader base S&P 500, 500 in that being the 500 largest companies in the market is up almost 12% year to date.
Justin Dyer (03:42):
Then just underperforming that is a Dow Jones Industrial Average. So this is one of those indexes that you hear and see everywhere, but it only represents 30 companies. And they're kind of these old school industrial companies, as it's implied in the name, that's returned about 10 and a half percent year to date. So not bad, really so far across the board, but if we drill in even a little bit further, the best performing sub-asset class, if you want to call it or sub part of the market are small companies. So Russell 2000 is the index to look out for those types of companies that index specifically has returned about 15 and a half percent. Looking a little bit outside of the US borders. Emerging markets is showing up around 5%, just under 5% again, as when we're recording this and then developed non US companies.
Justin Dyer (04:38):
So think about that, like Europe, Japan, countries that are outside the US borders, not emerging markets, those economies, those markets have returned about a seven and a quarter percent year date. So overall on the equity side, pretty good single digit to double digit returns thus far. What does that mean going forward? I mean, we're going to talk a little bit about that.
Justin Dyer (05:02):
And then I just want to highlight on the fixed income side, because that is an important component of our all portfolio construction and your financial structure, right? That's the ballast, the safety net, the dry powder. However, you want to think about it, that because of where interest rates have gone around the world, that part of the market has returned a slightly negative amount, just under a negative 1% rate of return. So, but expanding that beyond longer periods of time, you're still earning a decent return and that fixed income component is providing some utility or some benefit to the portfolio, which I know we've talked about through financial structure and portfolio construction in the past.
Erik Averill (05:51):
Justin, that's super helpful to know and it's interesting, right? Oh, I know a lot of our listeners and very candidly myself, when we think outside of traditional markets, those returns sound bleak compared to what you see going on the craze of the alternative space, right? In the crypto world, or even what it seems to be some of the returns that are being generated in the real estate markets in the private markets or venture or private equity and these types of things. And so, as an investor, I know I can find myself or those listening can try to look in the future and go, okay, I know I can't predict the future, but can I at least look at what has done well recently and base my investment decisions off of that, right?
Erik Averill (06:45):
That isn't it as simple as looking, what's the top performing country, what's the top performing asset class, what's the top performing specific company. And then shouldn't I just make most of my decisions off of that. But there's this really interesting disclosure in the financial or in the investment world that is plastered everywhere. There's a conversation and actually required when you're giving investment advice. It says, past performance does not guarantee future results. And so I'd love to hear your responses as I'm an investor who's thinking shouldn't I base my past performance or my future investment decisions off this past performance. Why is this disclosure exist? And how should I think about it as an investor?
Justin Dyer (07:36):
Yeah, it's great question. Well, the short answer is, it's there for a reason, right? The regulators have essentially seen how the market participants investors have reacted and been burned. And so they now therefore require that disclosure on there. And then also how brokers, the average Joe brokers, if you will try and sell advice, quote unquote advice, they will generally use performance because they know it's an easy thing to sell. And it's way more complicated to drill into something in a much more granular and accurate or appropriate way of thinking about how you're investing going forward. So, and that's how we should think about it, right? What's happened in the past is I don't want to say irrelevant. It's almost completely irrelevant, right? You can extract information from prices and what's happened in the past, but if you are making an investment, you should be making that investment looking forward.
Justin Dyer (08:49):
The market itself is generally forward looking. And so I think we've talked about on past podcasts, you need to bring in some amount of research, of analysis, fundamental statistical economic, whatever, however you want to call it and apply that to the investment you're making, make that investment based on what those assumptions are and do that looking forward, right? Looking back in the rear view mirror is rife with mines, right, or traps, if you will, if you're looking at it in this really myopic sense of just looking at performance, you're almost bound to have a bad investment experience. And I speak about that firsthand. I mean, when I was young getting into this industry, right, it's almost the easiest variable to look at, or it is easiest variable to look at.
Justin Dyer (09:49):
I mean, there's a million websites that have performance. You can look up every ETF, every stock, you can see it, you can see what it's done, you can see it's volume. And it's very easy to just latch onto that information, to make a decision on. And in general, it hasn't worked. It hasn't worked for myself personally, and it's not to say there's something around winners will keep on winning or losers will keep on losing. That's actually a well understood phenomenon called momentum, but it's not guaranteed to carry into the longterm.
Justin Dyer (10:26):
Momentum is something that actually happens over very short periods of time. It's hard to measure it accurately, so on and so forth. And I'm going down a little rabbit hole there, which I'll stop. But the short of it is, the disclosure is there for a reason. Our human mind wants to go after that easy, low hanging fruit data point to make a decision. And we think we're doing an in-depth analysis by doing so. And you could almost argue, and there are a lot of longstanding market participants and investors who will argue you should actually potentially do the opposite, right? Because there's something called mean reversion, where if an asset is going too high for too long, it's probably going to come back to some sort of fundamental value and same thing for assets that have underperformed for too long as well.
Erik Averill (11:19):
Yeah, you just mentioned there's an entire camp, right? That at times they'll throw around the names like Charlie Munger, Warren Buffett, in this contrarion viewpoint that says whatever the herd's doing, you should do the opposite. And it's not that simple, but what is built into that assumption is saying the reason the herd is moving is as not because there's a lot of intelligence behind her, or a lot of due diligence, it's people jumping on the bullet train that at some point, right. Might be heading to a cliff. And so you actually want to look at the contrarion, the undervalued companies to try and take advantage of it when it's out of favor. The, the comment you made that I thought was so interesting is talking about the disclosure, right, is that's actually put there to protect the consumer, the investor from poor practices or sales tactics from Wall Street.
Erik Averill (12:23):
And there's something embedded there. If you actually stop and go, they literally are doing this to protect us, which means this is not good for us. The other thing that came to the revelation and we've talked about this so much in other podcasts is, it goes back to the return conversation that if you are looking at, I want to get the highest returns, this is the wrong measure. And that's where the beginning of the train wreck begins. Because as you had mentioned earlier, fixed income, right? Like right now, we've heard this question. Why would I ever put money in fixed income? Well, if your measure of success of winning the game is return while you shouldn't put money in fixed income today. However, if we actually have a long-term view and our definition of success is achieving our priorities, what is going to give us the best pathway to give us the best consistent return to achieve the priorities that are important to us?
Erik Averill (13:30):
You want a well constructed total return portfolio, given the level of risk to meet those priorities over a given time span, right? And so, so much of the return conversation is so short-term, it's today, this week, this month, this year, yet the way you should be investing as an investor is how do I achieve my priorities at different time periods in the future? And so therefore, your target is not returns. It's a portfolio that's going to help me meet my priorities. And I just think that that is so, so, so important. One of the questions I do have though, Justin is, I hear you say, markets are forward looking so you shouldn't make it off of recent price performance. How is that really different than per say tilting portfolios to small cap, to value companies versus growth with an overlay of profitability? I mean, isn't that really just using past performance? What's the difference between those two?
Justin Dyer (14:41):
Yeah, I think it's the level of rigor, I guess if you will, you're you're not just looking, you're really not looking at a single variable performance. We're not going, hey, small companies have outperformed recently, so they should continue to outperform going forward. What we do when we're conducting that analysis and why we, what Eric's alluding to. And we've mentioned before, why we generally favor smaller companies or what are called value companies. Those that are trading at a lower valuation, multiple or metric is, because if you look over very long periods of time, those parts of the market will outperform the broader market as a whole. So think about going back to the indexes I quoted earlier, the S&P 500 or the Russell 3000, which is the top 3000 publicly traded stocks as well.
Justin Dyer (15:41):
And so the analysis and the data that points to the benefit of favoring, small companies and value companies is over a very long period of time. There's some behavioral components to it, as well as financial valuation components to it. And what I mean by that is take value companies, as an example, by systematically buying value companies are what you're doing is you're systematically buying cheaper companies in the market. You're getting an ownership interest in companies in publicly traded companies for a cheaper amount than you are for growth companies. So I mean, that's kind of the fundamental valuation principle you need to think about. If you're investing in a growth company, you're buying that company for a higher price, a higher dollar amount for every earning, every dollar of revenue that they bring in, you're paying more for that than you are for a value company.
Justin Dyer (16:52):
And so you're stacking the odds against you if you're just paying more for something, right. Just think about that logically, you're paying more for an ownership interest, regardless of what the underlying company is in this example, you're paying more for something. And so kind of logically you would think, well, if I'm paying more for something, I am better off if I try and go pay less, I will have a higher expected return going forward. Similar thing I'll touch on small caps real quick is, small companies are just inherently a little bit more risky. They're smaller, their ability to access cash in times of stress or debt markets in times of stress is a little bit more difficult. They can be swallowed up by larger companies. There's just more variables that make them a riskier company.
Justin Dyer (17:44):
Again, on balance we're talking in aggregate here, not talking about any specific company within that smaller realm or smaller arena. And so risk and return are related, right? If you're going to go back a small company, like think about the venture capital space or tech space, when venture capital investors, and we participate in that market, when you're going to invest in a small company that has a great idea, but has an unproven business model, you as an investor are going to require a higher potential rate of return for that. This same logic can then be translated into the small part of the public markets as well. So again, it's way more than just looking at, hey, the Russell 2000, like I mentioned, that's been the best performing part of the market so far this year. We don't take that and say, okay, that's going to continue to be the best performing part of the market.
Justin Dyer (18:41):
We look back way longer. We slice and dice the market up into various categories, small, large, value, growth, et cetera. And you look at how those perform over very long periods of time, try and have a framework, a fundamental framework of why that would actually exist. And then we make sure that that happens over time and throughout markets as well. If there's just far more rigor in involved in making that decision that we make to say, okay, let's favor small companies and value companies. Hopefully that answered your question in as simple way as possible.
Erik Averill (19:22):
I found it extremely helpful, even breaking it down to just the cost of the ownership, right? We talk about this is, we are partners and we own a company. And as people continually tried to buy our company, which we have zero plans of ever selling, because we're control freaks. It always comes down to valuation conversations, right? Like this, you would never have a conversation about buying or selling ownership without understanding valuations. And that's what we're doing is an investing standpoint. And the analogy I want to bring to the table for so many listening, that our community is made up of athletes, right? And even in the general public, we understand sports so well, is this is the complete amateur versus the pro. The amateur being the fan, playing fantasy sports versus the pro being the actual company, the team, the organization, the GM, the president is fantasy sports.
Erik Averill (20:20):
You fall in love with the momentum player. The guy who's got the hot hand, right, that night they just drained a bunch of three pointers and they've done it for a game or two or three, or on the field. The guys had a few home runs. There's a hot pitcher. The running back that breaks out for a game or two, and you start buying that player. The difference is the GM never constructs a team that way, why? Because they're in the business of making money. And so what do they do? They look of not who's just recency bias. Who's not popular right now.
Erik Averill (20:54):
It's hey, if I'm playing in baseball 162 games, and I'm trying to be a profitable company for decades, I look back and say, what are the analytics point to wins above replacement? What are the analytics actually say, if you remove the name on the Jersey and the excitement around what they've done recently, what are the fundamentals that lead to higher returns? So we talk about small cap value here in the investment world. In baseball, it's spin rate, it's strikeouts versus walks. It's these fundamentals that over the longterm lead to higher expected returns, and the reason small value-
Justin Dyer (21:34):
And it's what they cost, right?
Erik Averill (21:37):
Correct, it's absolutely what they cost. And then what they do, right. Billy Bean made it famous. Are there undervalued small value players that, you know what, they're not sexy names. They don't look the right part, right? They don't pass the eye test, but they produce returns, actually higher expected returns. And it's why sports have gone one of two ways. You've got super valuable companies like the Lakers or the Yankees, or the Dodgers that just keep spending money because they believe they can... Even though they're expensive, they believe they can produce those returns, or all the other organizations are throwing games. They're trying to be horrible so that they can get higher draft picks, right. At lower values to drive their valuation.
Erik Averill (22:22):
So we understand the world via sports here. And so I just think it's a great analogy. And so for our listeners, as we close out the conversation, we always are trying to commit it to say, hey, here are the principles to investing, right? And we highlighted over the last couple of weeks, we're walking through what are the 10 principles to investing like a pro. And so if you head over to awminsights.com, you can download those 10 key principles to investing. And until next time, own your wealth, make an impact and always be a pro.