ECONOMY

How to Build a Portfolio That Outperforms for a Century

There’s a scene in 2011’s “Moneyball” — the Hollywood take on Michael Lewis’s 2003 book — where economics grad Peter Brand describes a new approach to building a baseball team by finding value in players “that no one else can see.”

Baseball had traditionally relied on a network of scouts who would roam the country looking for new talent, often zooming in on the flashiest up-and-comers who reminded them of the great stars of the past. But by using rational statistical analysis, Brand argued, managers could identify and snap up “misfit” players that could then be used to create a cohesive team able to outperform over a season. The whole could be stronger than its individual (misjudged) components.

For Chris Cole, the founder of Artemis Capital Management, there’s a parallel between “Moneyball” and investing for the long-term. For years, he says, traditional fund managers have been trying to identify assets with the most potential to outperform on a risk-adjusted basis, relying on a narrow slice of history to back up their expectations. Managers are chasing the same kind of talent that worked before.

Cole’s solution is to build a portfolio able to survive big regime changes in markets and outperform over 100 years. The simple premise here is that focusing on each component’s individual performance can make a portfolio less resilient to big swings in markets — for instance moving from a deflationary regime where bonds outperform to an inflationary one where commodities surge. Or as he put it in a recent episode of Odd Lots:

In Cole’s portfolio, there’s space for things like long-volatility, commodities and momentum-strategies to work together with more traditional financial assets like stocks and bonds. That, he says, helps create a more robust portfolio where at least two of the five components (or “players”) are always outperforming no matter what market regime they’re in — be it inflation, deflation, stagflation, or whatever. Here’s Cole again:

If you go back to the “Moneyball” analogy, the Oakland As did well using statistical analysis that has since become the norm in sports, but they famously failed to win the playoffs. Why? Statistical models require volume, and the playoffs were just three games as opposed to the 162 games of a regular season. The team didn’t have enough competitions to revert to the mean.

What worked for the season didn’t necessarily work for a handful of games. In a similar way, Cole argues, investment strategies that outperformed recently might not be able to pull off the same thing over a hundred years. Or as he put it:

The full transcript of the interview with Chris Cole will be available soon on Odd Lots.

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