Hi Guys,
A few days ago MFOer Tampabay recorded that he was rooting for a Florida State win in the Rose Bowl. He was disappointed: Oregon 59 over Florida State 20. It was a disaster and not an especially well played game.
But it was not an unexpected disaster. I suspect that Tampabay’s enthusiasm was prompted by home-state loyalty, and not a careful analysis of the strengths and weaknesses of the competing teams. That’s a dangerous way to lay a wager or to conduct business.
Until the second-half of the Rose Bowl contest, Florida State had prospered from an unprecedented outlier-like string of comeback victories. No team can tempt defeat so often, and yet emerge with a late rally win in a consistent manner. Luck had to be a major factor. Florida State is just not that exceptional or talented.
And luck changes instantaneously at unpredictable, unexpected, and unwelcomed moments.
Florida State suffered their upset moment on New Year Day. Simply put, the Florida State team experienced a regression-to-the-mean. All good things must come to an end, to a reversion to more normal outcomes.
What is true in sports is equally true in the investment world. Outlier rewards are not sustainable. That’s why loading a portfolio with last year’s winners is most likely a loser’s game. The issue is not if a reversal will occur, but when that turnabout will happen. It will surely happen.
Nothing demonstrates this happening more clearly in the investment option world than the famous Periodic Table of Returns that is issued in many formats. I have discussed these illuminating Tables in many earlier MFO postings.
The evidence strongly suggests that forecasting future returns is an unfathomable task. That insight is embedded in the historical data sets themselves. It is nicely summarized in the various Periodic Table of market Returns charts. Here is a Link to the Callan Periodic Table:
https://www.callan.com/research/files/757.pdfHere is a Link to the MSCI Sector performance Periodic Table:
http://www.msci.com/resources/factsheets/MSCI_USA_Sector_Indices_Returns_and_Volatilities.pdfI have posted these references earlier, but they do need repetition to make the point memorable.
Financial writer Ben Carlson just published a column on this same subject. He titled the piece “Updating My Favorite Performance Chart”. Here is a Link to it:
http://awealthofcommonsense.com/I too consider this chart one of my favorites. It presents extremely broad asset class returns over a 10-year period.
The chart once again illustrates the random nature, the patternless character, the ramblings of the various major asset classes over the last decade. Good luck on consistently picking these winners ahead of time.
This is a big reason why active mutual fund managers have such a challenging task to outdistance an appropriate benchmark. It adds another dimension to investment risk. Forecasters can’t forecast with any reliability. It’s that reason plus the additional handicap of higher expenses in several directions that dampen active mutual fund returns. There’s an easy lesson here.
Please give the chart a little time. It’s worth the effort, and just might contribute to a more profitable 2015. I hope so. Good luck and good health to all.
Best Regards.
Comments
Oregon is a football machine. The big boys of old had better take notice. Oregon has been good for some years now but this years the stars aligned for them. It must be those cattle rancher's sons from the east side of the state. Bucking bales of hay before they go to grade school in the morning makes them strong. I don't know what they buck there in Florida?
I liked the MSCI table showing volatilities remaining fairly consistent, year to year, whereas returns are all over the place.
Happy New Year!
c
That was the first time Florida State had lost since November of 2012. Over the last three seasons FSU is 39-3. They were the defending NCAA National Champion and had the defending Heisman Trophy winner at QB. This Rose Bowl was competitive until FSU self immolated against another very good team who capitalized on every mistake. Sometimes bizarre results happen in sports. Ask the players from either of the NFL teams with the highest Elo Ratings since the NFL-AFL merger: The 1983 Washington Redskins or 2007 New England Patriots.
Oregon might well be a better team, but that certainly doesn't mean anything statistically relevant about FSU or their talent level. And I'm entirely unclear what it means for fund manager performance other than it might be much harder to tell when an aberration against a long term performance trend is luck-based, a symptom of a specific style, or reversion to the mean than people generally believe (2008/9 Dodge & Cox, for instance, or Matthews Asia's current under-performance). The Callen table is always cool to look at, though, so thanks for that link.
MJG, I always enjoy after-the-fact handicapping, you recapped it exactly, I guess that makes you correct in your analysis of Florida State and what happened, congratulations to you. I never heard you open your mouth before the fact , About Oregon or Florida State?
" That’s a dangerous way to lay a wager or to conduct business",
Bet you have never wagered your money or Owned a business in your life......
thus you don't know what is or isn't "dangerous"
I would suggest you regress to your forecasting by After the fact charts and links, so at least you will seem to know what your are talking about in Future investing and football.
Florida is not my home state but my choice of life style...... I Made well BEFORE I experienced it.
A marvelous way to be "right".
Thank you for reading and reacting to my posts. I really appreciate feedback since that implies that I reached both your minds and your emotions.
But I didn’t expect the harsh nature of your highly charged replies. I suppose football does cause such sharp reactions from some loyal fans; football touches many emotions and nerves. I’m not one who is so influenced by football.
I didn’t comment or forecast the outcome of the Rose Bowl game because I simply did not care one way or the other. I had no skin in the game although I have a close relative who has both her undergraduate and graduate degrees from Florida State. I try to never forecast since that is a Loser’s game.
My primary purpose in referencing the Oregon-Florida State game was to introduce the investment reversion-to-the-mean concept in a manner that would attract MFO readership.
From your replies, I succeeded, but not in the way I wanted. You focused on the peripheral introductory football analogy, and not on the main investment regression topic. I’m disappointed.
You guys misinterpreted the extent and the thrust of my football analogy. I was surely not writing about the Florida State 2012 and 2013 seasons. They were superb and honestly earned by a superior football squad directed by a Heisman quality quarterback in 2013.
My comments centered only on Florida State’s 2014 season. The 2014 team did not dominate opponents like in previous years. They fell behind in a majority of their 2014 games by huge negative margins, and were very fortunate (lucky) to pull these games out of the fire. Their escapes baffled handicappers. Professional odds makers estimate that the team had something like a 1 in 10,000 chance of winning all those games. I wanted to illustrate how quickly luck can evaporate.
Also, the Florida State quarterback in 2014 did not play to the high performance standards he established in his Heisman trophy year. Statistically, the Oregon quarterback possessed a much more impressive 2014 record. That’s why he won the trophy this year. In the future, he too will likely suffer a regression-to-the-mean.
I’m sorry that you fellows are so sensitive to the Rose Bowl outcome. It neither pleased me or displeased me whatsoever. My posting was designed to direct attention to the random, checkerboard character of major investment classes, their non-predictability, and their reversion-to-the-mean tendency. The football commentary was meant to be merely ancillary.
By the way, I do Las Vegas about three times a year, and sometimes (rarely) leave with a fatter wallet. I also ran a small consulting firm after retiring as the head of a major research operation. The lesson here is to not make wild guesses or false assumptions. You never know who is on the other end of the exchanges.
I really take no umbrage from your comments. Once again, thanks for reading my posts.
Best Wishes.
You've misread my post.
I grew up in Maryland and my whole family attended UMD, so I pretty much actively root against FSU at any moment in time. I don't really care about college football all that much either: None of my alma maters really compete in it and the whole thing just seems absurdly corrupt to me.
But you made the claim that Florida State "reverted to the mean" by holding up a singular lousy performance, and then tangentially ran that example into the supposed randomness of asset class performance.
However, a singular negative outlier in a series of very positive results is not an example of "reversion to the mean." That makes your metaphor really strained and undermines your larger point about investing.
You write lengthy posts about probability in investing, ostensibly to educate posters. But in this case you've conflated terms. For instance: "In statistics, regression toward (or to) the mean is the phenomenon that if a variable is extreme on its first measurement, it will tend to be closer to the average on its second measurement—and, paradoxically, if it is extreme on its second measurement, it will tend to have been closer to the average on its first." Given your insistence on rigor and fact, I thought that should be pointed out.
MJG "But I didn’t expect the harsh nature of your highly charged replies. I suppose football does cause such sharp reactions from...
I'M always surprised, by super sensitive posters on blogs sites that post opinionated information, and when they get a reaction (repost) THEY are surprised and "shocked" someone would Dare react, Sorry but that what these sites are for, otherwise what good is it for me to say how smart you are or what great after-thought information you provide?
"I also ran a small consulting firm after retiring as the head of a major research operation. The lesson here is to not make wild guesses or false assumptions. You never know who is on the other end"
I'm sorry sir but running a "small retirement business" and working for someone else's pay check in a research lab".....
Gives you NO insight to what it is like getting up every morning, out the door, to develop a business( as owner), pay your bills, provide for your family, have Fun, and secure a future....When you have done that in your life you are BEST able to comment on the "Dangerous" of Business, otherwise not... ....all in my lifetime experienced OPINION....
Sincerely Tampabay
If you're trying to guess whether small cap frontier market growth equities are going to outperform the Barclay's in 2015, that's anyone's guess. Over time, however...
The big meaning I get is that FSU ran into a better team than they had previously this season. And they played terribly with all those turnovers. If that has anything to do with investing, I'd say it demonstrates the foolishness of comparing apples (FSU's other opponents) with oranges (Oregon).
Thank you for the really nice exchange coupling charts like those generated by Callan and a reversion-to-the-mean investment strategy. A discussion of the merits and shortfalls of those charts and how they can be interpreted to improve investment outcomes was the main purpose of my original post.
I have been familiar with both the Callan charts and the reversion concept for many years. I am a fan of both. About a decade ago I asked myself the same question that is currently being explored on this thread.
Can you exploit the Callan rankings to better your investment returns?
A decade ago I did some analyses on this specific question; my answer was NO. Investing in last year’s top ranking winners or last year’s bottom ranking losers did more poorly than the S&P 500 Index as a benchmark. Unfortunately, I can not find my analyses, so I am reporting results from memory alone. That’s not reliable enough.
The good news is that professional financial organizations have completed similar analyses. These studies are just a little dated but they backstop my own work. One report is from Bearing the Bull that uses a J. P. Morgan chart similar to the Callan study. Here is the reference:
http://bearingthebull.com/2012/02/01/the-callan-conundrum/
This article demonstrates the benefits and the shortfalls of asset allocations. One shortfall is that a diversified portfolio has a low likelihood of reaching the best performance ladder heights. The benefits are that annual losses are never maximized and that portfolio volatility is significantly reduced.
Given that diversification lowers return standard deviations, here is a Link to a short Fidelity report that provides some excellent practical examples:
https://www.fidelity.com/learning-center/investment-products/mutual-funds/diversification
By exploring enough options, it is almost always the case that some correlation can be identified that ties one variable to some desired output. Of course, the challenge is to locate a strategy that holds water over the long-term future. It seems like holes always develop in the water buckets and leakage compromises the “great” correlation.
It appears that the Callan-like charts provide no immediate solutions other than the promise that portfolio diversification is a pretty good plan. That’s something. Enjoy the references.
Best Wishes.