Idiologies

To create a successful investment process you’re bound to have competing ideologies at times depending on where we are in the investment cycle.

Buy and hold strategy only works if you’re able to both buy and hold when markets crash. And while it can be difficult to follow your plan during a market crash you have to have a completely different mindset during a bull market.

To practice buy and hold you have to be a practicing contrarian when stocks are going down and a practicing trend-follower when stocks are going up. You have to be willing to use two competing schools of thought at different times. That’s not always so easy to pull off.

In many ways this is similar to the two most well-known quantitative investing strategies value and momentum. Each of these strategies seeks to take advantage of over- and under-reactions made in the market, but in very different ways. With a value strategy, stocks that have performed poorly for one reason or another become cheap as investors over-react by selling first and asking questions later. With a momentum strategy, stocks that have done well recently tend to continue doing well for short periods of time because investors initially under-react. Value and momentum each rely on mean reversion, but in different ways and over different time frames.

Both Value and Momentum have historically been shown to work well as stand-alone strategies. But these two contrasting ideas actually work very well when you pair them together because they can make up for each other’s deficiencies during certain market environments. Therefore, diversifying these two return streams helps increase risk-adjusted returns.

But the implementation of a value/momentum combination will never work if the investor isn’t willing to accept that there are two schools of thought that can complement one another.  Really this idea of dealing with competing ideologies will be true of any successful long-term investment strategy.

At certain times you will have to be willing to take an uncomfortable stance. Sometimes that means going against the crowd. Other times it’s going to mean going along with the crowd.

I think an actual contrarian strategy can be one in which an investor is willing to combine different approaches and consistently follow them throughout various points in the market cycle to manage risk and improve long-term performance.   [Ben Carlson]