1/ Only 6% of actively managed funds managed to beat the S&P 500 over a 20-year period.
If you look at it closely, the S&P 500 strategy is as simple as "buy big stocks".
Let’s dive into why this simple strategy works - and what it takes to outperform it 🧵:
If you look at it closely, the S&P 500 strategy is as simple as "buy big stocks".
Let’s dive into why this simple strategy works - and what it takes to outperform it 🧵:
2/ A company can get into the S&P 500 if it passes these three basic conditions:
1. The company should be from the U.S and shares should be highly liquid
2. Market cap > $8 Billion
3. Positive earnings in the recent quarter and positive total earnings in L1Y
1. The company should be from the U.S and shares should be highly liquid
2. Market cap > $8 Billion
3. Positive earnings in the recent quarter and positive total earnings in L1Y
3/ The strategy is as simple as it gets:
The index committee meets every quarter, reviews the companies in the existing list, and sees if any new companies can replace the existing ones using the above 3 rules.
That’s how Tesla got into the S&P 500 in Dec ’20.
The index committee meets every quarter, reviews the companies in the existing list, and sees if any new companies can replace the existing ones using the above 3 rules.
That’s how Tesla got into the S&P 500 in Dec ’20.
4/ The very nature of a market-cap weighted index means that the best companies eventually rise to the top and get added to the index and the losers fall out.
The cherry on top is that they let the winners ride as long as they are present in the top 500 list and are profitable!
The cherry on top is that they let the winners ride as long as they are present in the top 500 list and are profitable!
5/ The strategy works because they have remained consistent with it over the past 5 decades.
6/ They don’t wake up one day and say “you know what, tech stocks are booming and we should pivot to tech” or “the Fed is planning to increase interest rates - we should cash out and wait for the dip”
Year after year, they have stuck to the same plan, no matter what happened.
Year after year, they have stuck to the same plan, no matter what happened.
7/ The problem with actively managed funds is that they never stick to their strategy and keep tweaking it based on market movements.
8/ Value Line Funds is a classic example of how hard it is to stick to a well-established strategy.
It runs two services. One is their investment survey which identifies top value stocks.
The company also runs a mutual fund that follows a similar strategy.
It runs two services. One is their investment survey which identifies top value stocks.
The company also runs a mutual fund that follows a similar strategy.
9/ Investors who followed their stock picks had an amazing gain of 76% over a five-year period (inclusive of the dot com crash!), but those who invested in their mutual fund lost 19% during the same time period.
10/ The problem was that the fund never stuck to its own strategy and churned around its management team multiple times.
The new managers dipped into stocks that were lower rated by the company’s own algorithm in the hope of finding “hidden gems” - The results were disastrous!
The new managers dipped into stocks that were lower rated by the company’s own algorithm in the hope of finding “hidden gems” - The results were disastrous!
11/ If the market benchmark is based on “buy the biggest companies that are profitable”, shouldn’t we be able to do better by just going one or two steps deeper?
12/ That’s exactly what @jposhaughnessy
analyzed in his book What Works on Wall Street!
He just added one more layer to the stock selection process and the results were stunning:
analyzed in his book What Works on Wall Street!
He just added one more layer to the stock selection process and the results were stunning:
@jposhaughnessy 13/ Market Leaders - Invest in companies that are in the top half of the field - That is, greater than average in market cap, shares outstanding, cash flow, and sales.
Market Leaders were able to give close to double the return of the S&P 500 while having a slightly higher risk
Market Leaders were able to give close to double the return of the S&P 500 while having a slightly higher risk
@jposhaughnessy 14/ PE Ratio - Invest in companies that are in the bottom decile of the PE ratio. i.e, companies with the lowest PE ratio.
Over the last 5 decades, stocks with low PE ratios have done much better (~7x) than stocks with high PE ratios without having higher risk!
Over the last 5 decades, stocks with low PE ratios have done much better (~7x) than stocks with high PE ratios without having higher risk!
@jposhaughnessy 15/ Most Wall Street and investment experts often use mental heuristics for making important investment decisions.
When confronted with vast amounts of data, our brain has a funny way of taking shortcuts to help make decisions.
When confronted with vast amounts of data, our brain has a funny way of taking shortcuts to help make decisions.
@jposhaughnessy 16/ This can be based on the story that we hear about the company, our own personal bias towards the founders (Cough *Tesla* Cough), or our experience with the product - and in most cases, we would be wrong!
@jposhaughnessy 17/ Who knew beating the market would be as simple as adding one more layer to the market indices, proving the outperformance by backtesting it over decades of data, and then just sticking to the plan?!
@jposhaughnessy 18/ If you found this insightful, you can check out the various strategies we have created over the past year!
@jposhaughnessy 24/ Follow @mkt_sentiment for content that will make you a smarter investor.
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