Investment Management: Why You Need A Complete Rethink. (short version with links)

September 19, 2017

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Part 1 – The best assessment of Investment Management is not Returns.

Chasing past returns can be disastrous. So just looking at historical returns can lead to big problems.

Does your Investment Manager understand the difference between sound and unsound financial planning?









Why You Need A Complete Rethink. Part 1 – The best assessment of Investment Management is not Returns.


Volatility Adjusted Returns can be accurately calculated and should form the basis of initial analysis.  However, it is crucial that these volatility adjusted returns are repeatable.

Whether they are repeatable is always going to be subjective to some degree, but this element is as important as the analysis of past volatility adjusted returns.

Any investor who can demonstrate superior RVAR clearly offers something different and I believe superior investment results. RVAR would certainly have required a deeper analysis before investing in LTCM.

With RVAR an investor benefits from the prospect of peace of mind that comes with low volatility and consistent returns. This helps with life planning and lower levels of stress and anxiety. Over the long term it can be argued that it may also lead to higher long term returns, as the following examples suggest can be possible.

Part 2 – Stock/Bond Passive Allocation Strategies Are Nonsense!
The first stage for assessing any strategy is understanding why the approach being adopted will provide a clear edge in delivering RVAR. If the strategy can not articulate why it has an edge then, simply, it does not have one!

I believe that this is the case with many passive allocation strategies. Frequenty, the investment management business adopts a Stock/Bond Passive Allocation Strategy. Unfortunately, a deeper analysis shows that this idea contains major challenges, both historically and theoretically.

Investment Management: Why You Need A Complete Rethink. Part 2 – Stock/Bond Passive Allocation Strategies Are Nonsense!


Furthermore, given the recent advance in both bond and equity markets the chart below suggests this is the worst time in history to adopt a 60% equity / 40% bond passive allocation strategy. It projects a nominal return of around 1% over the next 12 years.



















In terms of RVAR, there are much better passive allocation models, based on over 40 years of data, as shown in the note above.

Part 3 – Money Management Alone Can Substantially Improve RVAR.

In this note, I focus on one of the most important steps to investment management improvement, which, should not be left out in investment advice. Money management systems can make a huge difference to portfolio returns.

The sole focus is to discover whether an investor, or analyst could improve his long term returns simply by using different money management rules for the very same trades or recommendations that are made over any given time period.

STS and Equal Risk Strategies on True Wealth

Money Management Systems are crucial to Investment returns.










Investment Management: Why You Need A Complete Rethink. Part 3 – Money Management Alone Can Substantially Improve RVAR.


How does a money management system like this alter RVAR, the metric for excellent Investment Management discussed in Part 1? In the following ways:

1. Each step taken in the direction of additional Money Management techniques above shows how simulated returns can improve, even as volatility declines, consequently, RVAR can improve.

2. The trailing stops can lower risk.

3. Equal risk per position, weights any portfolio to lower risk assets. The chart above suggests that despite the lower portfolio risk this creates, it actually increases returns! This can significantly improve RVAR.

4. Tight stops on re-entry can lower risk and so increase RVAR.

Overall, there is the possibility of improvement in RVAR just by implementing these Tradestops money management techniques or similar ones.

Additional conclusion also follow from the above, building on the conclusions from Part 2. 

1. In both Part 2 and Part 3, not only has it been shown how returns can improve, but also volatility can potentially be reduced at the same time! Together, therefore, there is an improvement in RVAR, by using both of these techniques together.

2. Importantly, these findings contradict the widespread belief that higher long term returns only come from taking higher risk. What is shown here is that by focusing on RVAR, long term returns can improve even as the volatility of those returns declines.

3. Investors who chase returns and in addition embrace a higher risk level in service to the hope of higher long returns may well be using two very bad equations for their long term investment returns!

4. In Part 1 I showed the increased risk of large losses in the long term by chasing returns. This is remedied by switching to the metric of RVAR

5. In Part 2 and Part 3, I have shown that long term returns can be improved by using strategies that carry less risk than traditional strategies. RVAR can steer the investor not only to the increased likelihood of higher long term returns, but also to increasing the likelihood of receiving those higher returns with lower risk.  


Part 4 – Active Asset Management. Further Steps To RVAR Improvement.

The case for a further improvements in RVAR from Active Asset Management can be shown from even a simple Active Asset Management system, which can be applied to a very long history of data.

A simple example shows the benefit of Active Asset Management










Investment Management: Why You Need A Complete Rethink. Part 4 – Active Asset Management. Further Steps To RVAR Improvement.

Next Stages of Active Asset Management. Further ideas for RVAR improvement

Naturally, there are infinite ways to develop active asset management systems, even beyond just trend based systems of the type described above. However, the more complicated the system and the less data there is, the more unreliable backtested results can become. Furthermore, backtested results always need special care concerning how repeatable any results could be.

Nevertheless, multiple systems, with multiple methodologies can be developed that suggest further RVAR improvement. Once this is achieved then combinations of Active Management systems can take RVAR improvement to an even higher level. Particularly when:

1. Active Management Systems are uncorrelated.

2. Active Management Systems focus on different sectors.

3. Active Management Systems focus on different time cycles/horizons.

4. Active Management Systems can be combined in a balanced and universal aggregate system. In this way, a whole portfolio can be constructed that will automatically adapt to many different investment environments.

Overall, the line of thinking outlined in these 4 parts can transform an investor’s risk and return outlook and peace of mind.

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