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Chasing Historical Performance

|Includes:Tesla Motors (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