March Madness For Investors

Process Based Strategies

Process-based investment strategies, on the other hand, have methods that establish expectations for the factors that drive asset prices in the future. Such analysis normally includes economic forecasts, technical analysis or a bottom-up assessment of an asset’s ability to generate cash flow. Process-based investors do not just assume that yesterday’s winners will be tomorrow’s winners, nor do they diversify just for the sake of diversification. These investors have a method that helps them forecast the assets that are likely to provide the best risk/reward prospects and they deploy capital opportunistically.

Well managed absolute return and value funds, at times, hold significant amounts of cash. This is not because they are enamored with cash yields per se, but because they have done significant research and cannot find assets that offer value in their opinion. These managers are not compelled to buy an asset because it “promises” a historical return. The low yield on cash clearly creates a “drag” on short-term returns, but when an opportunity develops, the cash on hand can be quickly deployed into cheap investments with a wider margin of safety and better probabilities of market-beating returns. This approach of subordinating the short-term demands of impatience to the long-term benefits of waiting for the fat pitch dramatically lowers the risk of a sizable loss.

A or B?

Most NCAA basketball pool participants fill out tournament brackets starting with the opening round games and progress towards the championship match. Sure, they have biases and opinions that favor teams throughout the bracket, but at the end of the day, they have done some analysis to consider each potential matchup.  So, why do many investors use a less rigorous process in investing than they do in filling out their NCAA tournament brackets?

Starting at the final game and selecting a national champion is similar to identifying a return goal of 10%, for example, and buying assets that are forecast to achieve that return. How that goal is achieved is subordinated to the pleasant but speculative idea that one will achieve it. In such an outcome-based approach, decision-making is predicated on an expected result.

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