The Race Car Optimization Fallacy

In my business, I am constantly approached by investment companies that want me to use their latest and greatest with my clients. More times than not, the latest and greatest is a fancy strategy with a fancy name that just sounds great: long/short, dynamic allocation, tactical allocation, active beta, smart beta, multi-manager…the list goes on and on. Every year there is a new hot strategy.

But here’s the thing: This ain’t my first rodeo. I have seen hot strategies come. I have seen hot strategies go. In the end, the results of these strategies rarely live up to the promise. All hat and no cattle as Paul R. Peeler, Sr. used to say.

What happens is that investment companies need to sell something to make money. And they come up with these exotic-sounding strategies, back-test on computers until they get a data set that supports the sales story, then trot it out to the public. Unfortunately, what shows up in computer-driven backtesting rarely shows up in real life.

I have a client that owns a high-end motorsports shop and often does consulting work for premium racing teams. I was telling Charlie about the aforementioned phenomenon, and he said, “Paul, it’s the same thing in my business! These racing folks come out with all these computer-driven formulas on how to optimize race cars. It all looks good on paper…but when we actually get it on the track, it’s a different story.”

When it comes to client portfolios, I have learned the basics always work best over the long haul: Asset allocation, diversification, cost containment, and patience. That’s the winning formula. It’s not terribly exciting and you’re not going to dominate the discussion at the next cocktail party like the guy who owns the hedge fund that hasn’t cratered yet, but it works.

I think Charlie would agree. But then again he’s not someone who’s very interested in winning the cocktail party.

If you would like to hear more about how we incorporate boring and effective asset management into the Integrated Core Process, we would be happy to talk with you. You can e-mail Jennifer Acosta (jacosta@intfingroup.com) to set a time to speak.