Financial Advice for Retirement, Social Security, IRAs and Estate Planning

The Frustrating Law of Active Management

October 9, 2017

Here’s an interesting piece from Pension Partners that re-enforces an investment principle too many people forget or never learned. No investment strategy performs well all the time. Even the best investors and investment strategies have periods of underperformance. That means to enjoy the benefits of a strategy that earns higher returns over the long term, you have to stick with it over those shorter periods when it isn’t doing well.

This is not just a case of perception, either.  Financial theory tells us that a strategy cannot always outperform its benchmark with certainty.  After all, if it did, we would have an arbitrage: we could go long the strategy, short the benchmark, and lock in certain profit.  As markets loathe (or, perhaps, love) arbitrage, such an opportunity should be rapidly chased away.  Thus, for a disciplined strategy to generate alpha over the long run, it must go through periods of underperformance in the short-run.

 

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