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Superforecasting For Active Investors

By Sammy Suzuki In a fiercely competitive world, active managers are constantly looking for ways to advance their performance edge. One good place to focus on is how to become better forecasters. If just looking at averages, the active management industry has a spotty record. But some active investors manage to beat the market consistently, suggesting that they possess some degree of skill. If you can identify them or become one of them, the payoff is large. The question is, what separates skilled investors from unskilled ones? Many people will answer that question by pointing to credentials or other markers: the manager seems especially smart, acts more authoritatively than others, shows more conviction or appears on TV more frequently. The problem is that none of these factors is necessarily correlated with increased predictive capabilities. In fact, some of them have a mildly negative relationship to it. In a world engulfed in random noise, performance itself is a fairly unreliable measure of skill in the short run. So what, then, are the traits common to the most skillful investors? A Teachable Moment We have some thoughts on the matter, largely drawn from the insightful research conducted by Philip Tetlock, professor at the Wharton School of the University of Pennsylvania and co-author of Superforecasting: The Art and Science of Prediction. The book is based on the findings from the Good Judgment Project, a multiyear study in which Tetlock and his colleagues asked thousands of crowdsourced participants to predict the likelihood of a slew of future political and economic events. As the book’s title suggests, “superforecasters” do, in fact, walk among us. Despite their lack of professional expertise, a small group of participants in the study significantly out-predicted both their fellow volunteers and teams of top professional researchers. And, over time, their advantage not only persisted, but grew. Most important, Tetlock found that good analytical judgment relies on a set of discrete approaches that can be taught and learned. With that in mind, we offer a framework for investors looking to improve. It’s About HOW You Think How forecasters think matters more than what they think, according to Tetlock’s research. In fact, how a person approaches a research question is the single biggest element distinguishing a great forecaster from a mediocre one. Predictive research is about focusing on the information that is most likely to raise the odds of being right: if you know x, your odds improve by y%. Superforecasters think in terms of probabilities; break complex questions down into smaller, more tractable components; separate the known from the unknowns and search for comparables to guide their view. Professional investors and research analysts gather reams of data to build their forecasting models, a lot of which has little proven predictive value. Our research shows, for example, that there is little correlation between a country’s GDP growth and how well its stock market performs. Good investment forecasting is akin to meditating in the middle of Times Square. It requires learning how to isolate the few relevant “signals” from a cacophony of irrelevant market “noise.” That’s not something most of us are taught how to do in our formal education. In areas such as math, science or engineering, the relationship between general laws and what you observe is much tighter. Stay Actively Open Minded In reality, the range of possible outcomes of any event is wider than most people can imagine. Outcomes usually look obvious after the fact, but they frequently surprise when they happen. Tetlock’s work suggests that a forecaster who considers many different theories and perspectives tends to be more accurate than a forecaster who subscribes to one grand idea or agenda. Being open minded also means accepting the (very real) possibility of overconfidence. Superforecasters also have a healthy appetite for information, a willingness to revisit and update their predictions as new evidence warrants and the ability to synthesize material from sources with very different outlooks on the world. Maintain Humility It takes a certain kind of person to have both the humility to accept that they may be overconfident in their assumptions and predictive powers and the conviction necessary to manage an investment portfolio. It also takes a certain type of person to learn from their mistakes without over-learning. The best forecasters were less interested in whether they were right or wrong than in why they were right or wrong. Using Tetlock’s words, superforecasters also tend to be in perpetual beta mode. Like software developers working on an untested app, these people rigorously analyze their past performances to figure out how to avoid repeating mistakes or over-interpreting successes. In the age of information overload, the active investor’s edge increasingly lies in knowing what information matters and how to process that information. If you can identify skill – whether you are looking to hire a portfolio manager or you are a portfolio manager aspiring to improve – we believe that this superforecasting framework can give you a better shot at beating the market. The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Sammy Suzuki, CFA – Portfolio Manager—Strategic Core Equities

FIS Upgraded As New Strategy Fuels Bullish Guidance, Notches High

Financial technology firm Fidelity National Information Services ( FIS ) (FIS) got an upgrade Wednesday in the wake of its investor day Tuesday, sending the stock briefly to a new high. Analyst Moshe Katri of Sterne Agee CRT lifted his rating to buy from neutral and set his price target at 85, writing that FIS is shifting away from project-based IT to more stable, higher-margin business lines. “In our view, one of the major reasons for the downward rerating of FIS’s valuation which in the past was at par with peers Fiserv ( FISV ) and Jack Henry & Associates ( JKHY ) (both with sticky/high-recurring revenue models) has been the company’s lackluster performance last year, triggered by its weak IT Services business,” Katri wrote in his upgrade note. “We believe the CEO’s message, pointing to exercising more stringent controls over (the) consulting arm, Capco, reflects management’s realization that cross-selling IT services or project-based business has been a major deviation from the company’s traditional model.” Credit Suisse analyst Paul Condra also noted that FIS had issued 2018 guidance above expectations, implying 14% EPS growth each of the next two years. He raised his price target to 76 from 71, though maintained his neutral rating. FIS’s stock hit an all-time high of 74.19 in early trading on the stock market today , though by early afternoon it was down a fraction, near 73.50. The stock broke out of a cup-with-handle base after its Q1 earnings report last week, and is now extended past its buy point. It holds a strong Composite Rating of 96, putting it in the top 4% of stocks.

One Size Fits All… If It’s Customized

Portfolio design comes in many flavors, but so do investors. Finding a sensible balance is job one in the pursuit of prudent financial advice. Yet for some folks the idea of keeping an open mind for customizing strategy to match an investor’s goals, risk tolerance and other factors reeks of treachery. There can only be one solution for everyone – all else is deceit. Or so some would have you believe. This biased worldview comes up a lot with the discussion of buy and hold, but the one-size-fits-all argument knows no bounds. The danger is that pre-emptively deciding how to manage assets for all investors is the equivalent of diagnosing illness and recommending treatment before meeting with the patient. Sound financial advice requires more nuance, of course, for two primary reasons: the future’s uncertain and the human species is afflicted with behavioral biases. In other words, a given investment strategy can be appropriate – or not – for different individuals. Consider the concept of buy and hold. By some accounts, it’s all you need to know. Stick your money in, say, the stock market and let the magic of time do the heavy lifting. Sensible? Perhaps. But it may be hazardous. The determining factor is the particulars of the investor for whom the advice is dispensed. Buy and hold – perhaps by focusing heavily if not exclusively on stocks via a handful of equity funds – may be eminently appropriate for a 25-year-old with a budding career, a saver’s mentality, and the behavioral discipline to focus on the long-run future. The same solution can be toxic, however for anyone with a time horizon of 10 years or less. Even for someone who’ll be investing for much longer, may run into trouble with buy and hold if he has a tendency to over-react to short-term events. In that case, buy and hold can be wildly inappropriate for an investor without the discipline to look through market crashes and bear markets. Ah, but that’s where a good financial advisor can help by keeping the client on the straight and narrow: Ignore the short-term volatility and stay focused on the long term. Fair enough, but it doesn’t always work. Some investors will bail at exactly the wrong time no matter how much hand-holding they receive. Deciding who’s vulnerable on that score can be tricky, but not impossible. Perhaps, then, a portfolio strategy with less risk – asset allocation – or the capacity to de-risk at times – some form of tactical – is more appropriate for certain individuals. The flip side of this equation is no less relevant. Forcing every client into a tactical asset allocation strategy simply because that’s your specialty (and/or it pays better for the advisor) is also misguided. Higher trading costs, taxable consequences and the inevitability of timing mistakes can and probably will take a bit out of total return over the long haul relative to buy and hold. The “price” of tactical can still be worthwhile for some folks, if the portfolio has a tamer risk profile. The point is that there’s no way to decide what’s appropriate without first understanding the client. Granted, a 25-year-old investor is more likely to benefit from buy and hold vs. a newly retired 65-year-old client. But there are exceptions and it’s essential to identify where those exceptions arise. The good news is that there’s an appropriate strategy for every client. The great strides in financial research and portfolio design capabilities via computers over the last several decades provide the raw material for building and maintaining portfolios that are suitable for any given client. Buy and hold may still be appropriate, but maybe not. The greatest strategy in the world is worthless if a client jump ships mid-way through the process. As such, the goal for managing money on behalf of individuals isn’t about identifying the strategy with the highest expected return or even the strongest risk-adjusted performance. Rather, the objective is to build a portfolio that’s likely to work for the client. That may or may not lead to a buy-and-hold strategy – or some variation thereof. Such talk is heresy in some corners. But matching portfolio design and management particulars to each client’s time horizon, goals, etc. – and behavioral traits – is the worst way to manage money… except when compared with the alternatives.