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Chris DeMuth Jr. is the founder of Rangeley Capital LLC. Rangeley is an investment firm that focuses on event driven, value-oriented investment opportunities. Rangeley Capital and his value investing forum, Sifting the World (StW), search the world for misplaced bets. Rangeley exploits them for... More
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  • Chasing Historical Performance 14 comments
    Apr 16, 2014 11:30 AM | about stocks: TSLA

    They think that they want to catch it, but would be sorry if they did.

    I see patterns. It has been an evolutionary advantage to see patterns such as the shape of predators hiding in tall grass. Unfortunately, that advantage can lead to people being jumpy and to see patterns where there are none. One dangerous way that people see patterns is to linearly extrapolate recent stock performance. This phenomenon has been widely studied, but here is one more observation based on a recent project that I've undertaken.

    Due to an unnatural obsession with free money, I signed up for Motif Investing in order to collect $100 that comes with signing up (here if anyone is interested in reading what has been one of my least popular posts to date with the most snarly of comments).

    My ideas attracted a modest amount of interest as indicated by a few people who signed up for Motif via my link as well as the few who bought my portfolios. Happily they have, on average, done well so far. But what really attracts a following? I have gone through the data regarding what people buy and it is clear and unsurprising: recent positive performance. What happens next? Mostly mean reversion and losses. This is much in keeping with the academic literature on the subject which shows investor performance trailing every asset class over the long-term.

    How do Motif Investing customers pick among the professionally built portfolios? They appear to like strong recent performance. Looking backwards at the last year, the top five most popular portfolios include the most faddish, promotional, and momentum-driven ideas. From the top they are: Biotech Breakthroughs, Cleantech Everywhere, Chinese Solar, 3D Printing, China Internet. Before looking, I guessed biotech, clean tech, China, and 3D but incorrectly assumed that the cloud would make it into the top five. These have all been stunners in the past - +30%, 88%, 154%, 19%, and 99% over the past year. Wow. Each of these ideas are exciting and uplifting. The #1 performer offers, the "next big cure for a complex, scary disease". The second lets one associate with awesome companies such as Tesla (NASDAQ:TSLA). The third, Chinese Solar, is sort of a fad squared. Overall, one might cure cancer, stop global warming, and make high double digit if not triple digit returns per annum. One could retire in style and while solving the world's gravest problems. Advocates typically rely on the time-tested teenage arguments of, "this is the future, man" and to skeptics, "dude, you just don't get it".

    What about community created Motifs? Here, purchasers favored Profitable Solar, Growing Asia, 1 to 5 Dollar Stocks, RNA Therapeutics, and Small Cap China. I don't know how much specialized expertise the purchasers had in these areas but one strongly suspects that they were driven by performance - +129%, +95%, +97%, +18% and +52% over the past year.

    So, we have popular, awesome, and spectacular performance over the past year leading up to recent purchases. How have they done? The five amateur-built portfolios have losses of -17%, -13%, -17%, -29% and -15% this past month. The professionals have suffered from a similar reversion to making sense: -12%, -10%, -24%, -15%, and -8%. What sort of apocalypse befell the capital markets leading to this catastrophe?

    Stocks? Over the same period, the SPDR S&P 500 is positive by 0.04%:

    Bond? The iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is up by almost 2%:

    So, the most popular Motifs have massively underperformed during a benign period for markets. Is there anything wrong with Motifs? Let's examine the least popular ones, those with the biggest net withdrawals. The five most unloved professionally built Motifs were up 2.7%, 0.3%, 0.6%, 0.5%, and 0.4% over this past month. It is not entirely clear how many investors specifically avoided these positive returns in order to pile into the fads. However, it is clear that the least popular Motifs did fine - with the five least popular professionally-built combined with the five least popular amateur-built portfolios up an average of over 1% for the month.

    Much like any other type of business, brokerages such as Motif give their customers what they want. On Motif's homepage you are greeted with the prospect of riches by investing in portfolios such as Robotic Revolution, IBD Top 25, Obamacare, and Defensive Dividends. Combined with a time machine, these ideas would be winners. They were +32%, 22%, 33%, and 19% over the past year. However, once mean reversion took its toll, investors who bought what what most prominently advertised took some hits: -5%, -14%, -7%, and flat for anyone who bought this past month.

    In conclusion, if you want to attract purchasers, strong recent performance appears to be a key element. However, if you are a purchaser, strong recent performance will not help in prospective performance.

    Stocks: TSLA
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Comments (14)
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  • afr6262
    , contributor
    Comments (48) | Send Message
    I wonder how well you would do if you bought the motifs that held up the best during a correction but not the ones that performed the best during a huge upmove in the market.
    16 Apr 2014, 12:20 PM Reply Like
  • TheCompleatAngler
    , contributor
    Comments (177) | Send Message
    CD, your phrases "to linearly extrapolate recent stock performance" and "mean reversion and losses" are echoed in passages from a book published long ago-- the first edition of Security Analysis by Graham and Dodd (1934). From pp. 433-434:


    "The mistake of the market lies in its assumption that in every case changes of this sort [in the earnings trend] are likely to go farther, or at least to persist; whereas experience shows that such developments are exceptional and that the probabilities favor a swing of the pendulum in the opposite direction.
    it must be remembered that the automatic or normal economic forces militate against the indefinite continuance of a given trend. Competition, regulation, the laws of diminishing returns, etc., are powerful foes to unlimited expansion; and in smaller degree opposite elements may operate to check a continued decline. Hence instead of taking the maintenance of a favorable trend for granted--as the stock market is wont to do--the analyst must approach the matter with caution, seeking to determine the causes of the superior showing, and to weigh the specific elements of strength in the company's position against the general obstacles in the way of continued growth."
    16 Apr 2014, 01:48 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (11736) | Send Message
    Author’s reply » Yep! Without G&D, I'd be nothing (at least nothing related to capital markets). Just a wood splitter in the back woods.
    16 Apr 2014, 02:36 PM Reply Like
  • Behr Investments
    , contributor
    Comments (15) | Send Message
    How were you able to determine what motifs had the biggest net withdrawals?


    I have wondered why when you choose to "explore motifs" you are presented with motifs sorted by greatest 1 month return by default. This seems like a guaranteed way to lose money.
    16 Apr 2014, 04:02 PM Reply Like
  • jawats
    , contributor
    Comments (7) | Send Message
    People would ask my father-in-law, who owned a successful trust management company, for his recommendation on stocks. He would glance around, lean in, and mutter conspiratorially "The trend will continue until it reverses."
    17 Apr 2014, 03:20 PM Reply Like
  • TimeOnTarget
    , contributor
    Comments (3679) | Send Message
    Chris --


    This is a really good post. Certainly did me good to read. Thanks.


    It also jibes with my personal experience. The things I tend to do well on are battered down stocks where I actually dig deep and do my homework. When I lose money it is usually hearing something that I think is hot and thinking I am at the beginning of the "trend" when I am actually the last man aboard.


    Of course, if I ever think I would be the last man aboard, it turns out that the trend was barely beginning -- like my brilliant analysis in 1994 that Dell was overpriced and overhyped. The best part about that decision is how I closely watched it over the next five years get ever more overpriced and overhyped without buying a share (I live in Austin). I was able to go back and look at when I thought about buying it vs. what it got to 5 years later. It would have been a 99X return. On second thought, I don't want to talk about it.
    17 Apr 2014, 08:29 PM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1518) | Send Message
    Momentum investing does work. It is not my style but many have made fortunes investing with the trend. I for one thought twitter was insanely overvalued at 50 then it went to 74. Tesla looked outrageous to me last year at 100 before doubling. Investors business daily and hundreds of newsletters make their living off momentum. Again I am on the value team and mean reversion is in my DNA. In different markets different styles and strategies work
    18 Apr 2014, 09:02 PM Reply Like
  • ellaruth
    , contributor
    Comments (1094) | Send Message


    Thanks a lot, this is a tremendous article. Assuming that that the earnings growth per share is equal. What factors would one look for in order to have a haunch on the stock that would continue to double or triple again versus the one that would stall and continue with slow growth?


    19 Apr 2014, 09:31 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (11736) | Send Message
    Author’s reply » I would start with looking for something at a deep discount to its intrinsic value. Then I would look for a potential corporate event to unlock that value and return it to the equity owners.
    20 Apr 2014, 09:04 PM Reply Like
  • bazooooka
    , contributor
    Comments (3688) | Send Message


    This is the type of stock, MKL, that has doubled in the past and likely will do so again over the "long" term.

    21 Apr 2014, 01:36 PM Reply Like
  • Karma-hurts
    , contributor
    Comments (3) | Send Message
    Great post. Thanks Chris!
    22 Apr 2014, 07:35 AM Reply Like
  • Approximately Right
    , contributor
    Comments (29) | Send Message
    I too joined Motif purely out of a love of free money (no apologies!), and I agree that it's yet another fascinating window into investor psychology. I typically track fund flows to look for contrarian signals; perhaps I'll start using Motif popularity/withdrawals for similar purposes.


    BTW, I used Motif to build a globally diversified portfolio loosely based on the ideas in Meb Faber's Ivy Portfolio book. I'd say it's an excellent tool for such a purpose. I saved quite a bit of money by incurring only a single transaction fee to construct a portfolio (actually, I was paid about $90 to buy the portfolio if you include the bonus I received) that would have required 10-15 individual purchases through another broker.
    22 Apr 2014, 12:56 PM Reply Like
  • TheSandman
    , contributor
    Comments (171) | Send Message
    My $100 Motif dollars were deposited to my kid's savings account today. Thanks for the heads up!
    17 May 2014, 12:15 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (11736) | Send Message
    Author’s reply » TheSandman, that makes me happy. I love opportunities with good safety and risk:reward even if not scalable. Kids' savings accounts are great because they make me happy everytime there is something to deposit. With wise stewardship, $100 could be worth a lot of money someday.
    17 May 2014, 07:17 AM Reply Like
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