The Trouble With Chasing Hot Strategies | Josh Brown

This should be blindingly obvious, but amazing how often it is ignored. Great post from Josh Brown at Reformed Broker:

How do most investors (and many advisors) select funds or strategies to allocate to? They look at what’s been working, learn the story and get long…….
And then mean reversion shows up – outperforming managers subsequently underperform, hot themes become over-loved, winning strategies become too crowded to offer excess returns. “No problem,” says the advisor, I’ve got six new ideas to replace the six ideas that are no longer working!”

It’s sad to say, but this is exactly how it works. I’ve been watching this for almost 20 years…….

Research Affiliates has an interesting pair of charts demonstrating this phenomenon in a new note from Rob Arnott, Jason Hsu and Co. They illustrate that increasing fund flows are a decent predictor of subsequent underperformance and that performance-chasing is destructive to returns across all types of investment products:

Research Affiliates

3 thoughts on “The Trouble With Chasing Hot Strategies | Josh Brown

  1. […] is more likely to attract our attention than more stable longer-term performance. Josh Brown highlighted last year that mutual funds that attracted the most new investment tended to underperform funds that […]

  2. Vic Russo says:

    Colin, does this mean that all momentum-based strategies are doomed?

    • ColinTwiggs says:

      Not at all, Vic.

      Momentum has been shown to work over more than 100 years but there are times when momentum outperforms and times when it underperforms the market. What advisors and investors tend to do (as with most other strategies) is withdraw funds when momentum has underperformed and come flooding back when momentum has been performing well. That often means they buy at the ‘top’ and sell at the ‘bottom’ — missing the best performing years while catching the worst.

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