The Perfect Bull Market Portfolio Might Have Blown Up Your Firm

Bloomberg

Would you do it all over, knowing what you know now? For a professional money manager looking back on the bull market at its 10th anniversary, it’s a hard question to answer.

Would you do it all over, knowing what you know now? For a professional money manager looking back on the bull market at its 10th anniversary, it’s a hard question to answer.

Here’s a thought. Imagine you knew exactly which stocks to pick a decade ago, the ones that would do best during the rally — like, literally. You knew Jazz Pharmaceuticals would soar 23,000 percent, that Abiomed and Netflix would rise more than 60 fold and Exact Sciences would go from 78 cents to $85. You were granted that knowledge, and you went out and bought those stocks. What would life have been like on the way to world-beating gains?

Worse than you think. From time to time, big losses are inescapable even in a portfolio chosen with 20–20 hindsight, with underperformance often dragging on long enough to put a money manager’s job in jeopardy.

Source: Tao Wang, Alpha Architect

The idea is a variation on an experiment tested three years ago by the research firm Alpha Architect, in a study designed to demonstrate how futile it is for professional investors to try always to outperform. The paper, “Even God Would Get Fired as an Active Manager,” showed that perfect stock-picking clairvoyance over long stretches wouldn’t spare a money manager from rough patches that would threaten his career.

Researchers looked at the period all the way back to 1927 but Alpha Architects’s founder, Wesley Gray, and quantitative researcher Tao Wang agreed to run the numbers on the bull market to see how the perfect portfolio fared in honor of its latest anniversary. And while the pain of owning only winners was a little less over the last decade, the results still cast a brutal light on life on Wall Street.

First the (somewhat obvious) good news. An equal-weight portfolio comprising the best 100 stocks in the Russell 1000 since the bottom of the financial crisis would have returned nearly 20 times the benchmark, according to data compiled by Alpha Architect. But while arriving at that destination felt great, the travel it took to get there was rough.

Take 2011, for example. Stocks that ended up trouncing the S&P 500 over the decade fell behind the benchmark by as much as 10 percent for part of that year, a dose of weakness that would’ve tested a client’s patience. The perfect portfolio plummeted more than 22 percent at one point — six percentage points more than largest drawdown for the S&P 500. Just half a year later, the god group suffered a three-month stretch of trailing its benchmark again. (The firm calculated returns at monthly intervals, not daily.)

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Source: Sarah Ponczek | Bloomberg

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