Behavioral Portfolio Management - CFA Institute Calendar... · 2015-09-24 · Behavioral Portfolio...

Behavioral Portfolio Management:A New Paradigm for Managing Investment Portfolios

CFA Society of NebraskaSeptember 23, 2015

C. Thomas Howard, PhDEmeritus Professor of Finance

Daniels College of Business

CEO and Director of Research

AthenaInvest, Inc

Portfolio Manager, Athena Value Mutual Fund

Athena Pure Valuation | Profitability

#1 Performing Small Value SMA for 2013

Morningstar Advisor

Barron's Separate Account Winner Q1 and Q2 2013

PSN Top Guns 2010, 2011, 2012, 2013, 2014

PSN Best Of The Best 2013

Athena Global Tactical ETFs

#1 Performing Managed ETF Portfolio for 2013

Morningstar Advisor

PSN Top Guns 2013, 2014

Athena Equity Income

PSN Top Guns 2014

Wealth & Finance

AthenaInvest Highlights

C. Thomas Howard, PhD

CEO, CIO, Director of Research

AthenaInvest

Professor Emeritus

University Of Denver, 35 years

Deep Academic Foundation

NYU, Yale, Harvard, MIT, DU

Patented Behavioral Research

© 2015 AthenaInvest, Inc. US Patents 7734526, 8352347, 8694406 & Singapore Patents 150371 & 184692.

All Rights Reserved. For Profession use only.

Most Important Drivers of Long Horizon Wealth

Primitive Emotions

Cognitive Errors

Behavioral Price Distortions

3



Source: AthenaInvest, Thomson-Reuters Financial, Center For Research In Securities Prices, St Louis Federal Reserve FRED data base.

4

$7,903,736(11.0%)

$430,713 (6.1%)

$162,433 (4.5%)

$73,851 (3.2%)$0

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

$7,000,000

$8,000,000

$9,000,000

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Asset Class Returns: $10,000 Invested in 1950 - 2014

S&P 500

T-Bond

T-Bill

CPI

Cost of Emotions: Asset Class Diversification



Based on regressions of Fama and French Market Returns and one month ahead standard deviation on previous day VIX. Daily data from Jan 1990 – May 2015. Sources: Yahoo Finance and Ken French’s website.

5

Cost of Emotions: Volatility Panic

0

2

4

6

8

10

12

14

16

18

20

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

An

nu

al

Co

mp

ou

nd

Re

turn

Previous Day VIX

Expected Stock Market Return vs VIX

Convergence of Two Research Streams

Modern Portfolio

Theory

Behavioral

Science

Finance

Research

Behavioral

Finance

6





BPM Basic Principles

1. Emotional Crowds dominate market pricing and volatility

– Prices rarely reflect underlying fundamentals

2. Behavioral Data Investors can earn superior returns

– BDIs take positions different from the crowd

– Emotionally challenging to do so

3. Redefining Risk as the chance of underperformance

– Volatility and risk are not synonymous

– Volatility is emotion

7



Behavioral Portfolio Management

Release Your Emotional Brakes

Understand Randomness

Move Beyond MPT

– Rationality Model

– Sharpe Ratio

– Tracking Error

8

IMPLEMENTING BPM:

RELEASING EMOTIONAL BRAKES

9



Investor Cognitive Errors

Myopic Loss Aversion

Social Validation

Availability Bias

Availability Cascade

Representativeness

Framing

WYSIATI

Anchoring

Fallacy of Information

Fallacy of Control

Peak-end Memories

Fooled by Randomness

Phantastic Objects

Thinking, Fast and Slow by Daniel Kahneman 2012

10



IMPLEMENTING BPM:

UNDERSTANDING RANDOMNESS

11



S&P 500 Annual Returns: 1926-2014

Rates of Return

2006

2004

1993

2000 1988 2003 1997

1990 1986 1999 1995

1981 2005 1979 1998 1991

1977 1994 1972 1996 1989

1969 1992 1971 1983 1985

1962 1987 1968 1982 1980

1953 1984 1965 1976 1975

1946 1978 1964 1967 1955

2001 1940 1970 1959 1963 1950

1973 1939 1960 1952 1961 1945

2002 1966 1934 1956 1949 1951 1938 1958

1974 1957 1932 1948 1944 1943 1936 1935 1954

1931 1937 1930 1941 1929 1947 1926 1942 1927 1928 1933

-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60%

Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future

performance, and are not indicative of any specific investment.

2010

2011Since 1926, U.S.

market produced

positive annual returns

73% of the time

Volatility and Tail Events

2012

2008

2009

2007

2013

12



2014

IMPLEMENTING BPM:

PLANNING FRAMEWORK

13



© 2014 AthenaInvest, Inc. US Patents 7734526, 8352347 & Singapore Patent 150371. All Rights Reserved.

For use by Investment Professionals only. 14

TRADITIONAL APPROACHES ARE NOT WORKING

60/40

• Multiple Objectives

• High Correlations

• Low Bond Yields

Style Boxes

• Hurts Performance

• Highly Correlated

Complex

• Over-diversified

• Global Mush

• Weak Performance

Equity Bonds

Value Core Growth

Large

Mid

Small



Needs Based Planning

15

Component Point of View

Goals & Needs Separate Short & Long

Time Horizon 10-20-30+Years

Asset Class Expected Returns

Investment Selection Excess Returns

Investment Risk Underperformance

IMPLEMENTING BPM:

EXCESS RETURNS

16





Truly Active Equity FundsActive Management Research

• Amihud & Goyenko

• NYU

• R-squared

Active Management

(Active)

• Cohen, Polk & Silli

• Harvard, MIT, LSE

• Relative Weight

Best Ideas

(Conviction)

• Howard

• Denver University

• Own Strategy Stocks

Strategy

(Consistency)

Consistent

Research

Results

4%-6%

Excess

Returns

17



BPM Benefits

2.3

7.38.9

14.8

20.9

0

5

10

15

20

25

T-Bills S&P 500 Truly ActiveFunds

Best IdeaStocks

BestMarkets

Annual R

etu

rn

For the period April 1997 through September 2014. For details regarding truly active funds (DR5 funds), Best Idea Stocks

(DR5 stocks), and Best Markets, visit AthenaInvest.com. Data sources: AthenaInvest, Thomson Reuters Financial, and Lipper

18

USING BEHAVIORAL FACTORS TO SELECT

TRULY ACTIVE MANAGERS&

BEST IDEAS STOCKS

19





Manager Behavior is Key

• How a manager goes about making money:

investment strategy

• Strategy consistently pursued

• Takes high conviction positions

Focus on Manager Behavior:

Strategy, Consistency, Conviction

20

Strategy Peer Groups

Competitive Position: Business principles, including

quality of management, market power, product reputation,

and competitive advantage. Consider the sustainability of

the business model and history of adapting to market

changes.

Economic Conditions: Top down approach based on

economic fundamentals; can include employment,

productivity, inflation, and industrial output. Gauges where

overall health of economy is in business cycle, resulting

supply and demand situations in various industries, and best

stocks to purchase.

Future Growth: Companies poised to grow rapidly

relative to others. The Future Growth and Valuation

strategies are not mutually exclusive and can both be

deemed important in investment process.

Market Conditions: Consideration of stock's recent price

and volume history relative to the market and similar stocks

as well as the overall stock market conditions.

Opportunity: Unique opportunities that may exist for a

small number of stocks or at different points in time. May

involve combining stocks and derivatives and may involve

use of considerable leverage. Many hedge fund managers

follow this strategy, but a mutual fund manager may also be

so classified.

Profitability: Company profitability, such as gross margin, operating margin, net margin and return on equity.

Quantitative: Mathematical and statistical

inefficiencies in market and individual stock pricing.

Involves mathematical and statistical modeling with

little or no regard to company and market

fundamentals.

Risk: Control overall risk, with increasing returns a

secondary consideration. Risk measures considered

may include beta, volatility, company financials,

industry and sector exposures, country exposures,

and economic and market risk factors.

Social Considerations: Company's ethical,

environmental, and business practices as well as an

evaluation of the company's business lines in light of

the current social and political climate.

Valuation: Stocks selling cheaply compared to peer

stocks based on accounting ratios and valuation

techniques. The Valuation and Future Growth

strategies are not mutually exclusive and can both be

deemed an opportunity strategy, but a mutual fund

manager may also be so classified.

21





Desirable Active Equity Characteristics

• Focused strategy

• Smaller funds

• Limited number of stocks

• Low R-squared

• High tracking error

• High style drift

• High Active Share

• Solo manager is desirable

• Brand name of limited value

In short, avoid closet indexing!

22



Stock and Fund Rating Process

• Strategy Identify Funds

• Measure Consistency

• Measure Conviction

Rank Managers

• Strategy Identify Stocks

• Measure Conviction

Rank Holdings

Best Managers

(Funds)

Best Investments

(Stocks)

Monthly Process (22,000 Funds and Holdings) Patented Behavioral Algorithm

23

HIGH CONVICTION EQUITY

24





Concentration & Volatility

0

5

10

15

20

25

30

35

40

45

50

0 5 10 15 20 25 30 35 40

Number of Stocks

Portfolio Annual Standard Deviation (%)

Assumes stock standard deviation of 45% and inter-stock correlation of 0.33. Based on Evans, J.L., and S.H.

Archer (1968), Diversification and the reduction of dispersion: an empirical analysis, Journal of Finance, 23,

761-767.

25



Pure Valuation | Profitability

• BPM Proof Of Concept

• Strategy -Valuation | Profitability

• Consistently Pursued - 13 year track record

• High Conviction - 10 stocks

• Results – 3.5% annualized alpha previous 10 years

• Recognized for performance - Barrons/Morningstar/PSN

26



US Active Equity Mutual Funds

Based on 44 million holdings for all US Active Equity Mutual Funds from May 1997 – September 2014. Stocks are ranked

within each fund based on its relative weight which is the stock’s portfolio weight minus the stock’s market cap weight within

the fund. Fund returns are net of fees and best fit R-squared index return.

Data sources: AthenaInvest, Thomson Reuters Financial, and Lipper

27

10.7

4.0

-2.0-1.4

-0.7

-2.7 -2.7-1.9 -1.6

-0.4

0.0

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

1-10 11-20 21-30 31-40 41-50 51-60 61-70 71-80 81-90 91-100 100+

An

nu

al B

asis

Po

ints

Relative Weight Ranks

Annual Fund Alpha Change per 1% Relative Weight Increase

USING BEHAVIORAL FACTORS TO SELECT

BEST MARKETS

28



Behavioral Market Barometers

Strategy Rankings

1988-2007

Rank Strategy

1 Future Growth

2 Competitive Position

3 Opportunity

4 Profitability

5 Quantitative

6 Valuation

7 Market Conditions

8 Economic Conditions

9 Social Considerations

10 Risk

Current Relative

Ranking

Aligned

Mixed

Inverted

Expected

Returns

High

Med

Low

29

Advisor Perspectives - Tom Howard

“Forecasting Market Returns July 19, 2011“© 2015 AthenaInvest, Inc. US Patents 7734526, 8352347, 8694406 & Singapore Patents 150371 & 184692.




Best Markets Implementation

30

AND IN CLOSING…

31





BPM Benefits

32

2.3

7.3

8.9

14.8

20.9

0

5

10

15

20

25

T-Bills S&P 500 Truly ActiveFunds

Best IdeaStocks

Best Markets

Ann

ua

l R

etu

rn

For the period April 1997 through September 2014. For details regarding truly active funds (DR5 funds), Best Idea Stocks

(DR5 stocks), and Best Markets, visit AthenaInvest.com. Data sources: AthenaInvest, Thomson Reuters Financial, and Lipper

Concentration

Tracking

Error

LeverageEmotional Brakes

Volatility



Long-term Cost of Emotions

$1,000,000 invested over various investment horizons

33

Returns 10 Years 20 Years 30 Years

4% 1,480,244 2,191,123 3,243,398

6% 1,790,848 3,207,135 5,743,491

8% 2,158,925 4,660,957 10,062,657

10% 2,593,742 6,727,500 17,449,402

12% 3,105,848 9,646,293 29,959,922

14% 3,707,221 13,743,490 50,950,159

16% 4,411,435 19,460,759 85,849,877

Bonds

Stocks

Active

Equity

Contact Information

34

• C. Thomas Howard, PhD

• CEO & Director of Research

• [email protected]

• AthenaInvest

• 877- 430 - 5675 x 100

• www.AthenaInvest.com

Important Information

• The figures shown are past results. Past performance does not guarantee future

results. There are risks involved with mutual fund and stock investing, including the

risk of loss of principal. There is no assurance that the investment process will

consistently lead to successful results. Investing in securities involves inherent risks,

including the risk that you can lose the value of your investment.

• The unmanaged Standard & Poor’s (S&P) 500 Index is a market value-weighted

index of large-cap common stocks considered representative of the broad market.

Total returns for the unmanaged index include the reinvestment of dividends and

capital gain distributions but do not reflect the costs of managing a mutual fund.

• Opinions and forecasts regarding industries, companies, countries and/or themes,

and portfolio composition and holdings, are all subject to change at any time, based

on market and other conditions, and should not be construed as a recommendation of

any specific security.

• You should consider the investment objectives, risks, charges, and expenses

carefully before investing. The fund brochure contains this and other information, and

may be obtained from AthenaInvest at 877-430-5675. Be sure to read this material

carefully before investing.

• For more information please visit us on the web at www.Athenainvest.com.

• © 2015 AthenaInvest, Inc. US Patents 7734526, 8352347, 8694406 & Singapore

Patent 150371 & 184692. All Rights Reserved.

• For use by Investment Professional only.

35

http://www.atheninvest.com/

Behavioral Portfolio Management - CFA Institute Calendar... · 2015-09-24 · Behavioral Portfolio...

Documents

Transcript of Behavioral Portfolio Management - CFA Institute Calendar... · 2015-09-24 · Behavioral Portfolio...