Financial market unicorns are the magical market elves that grind out eye-popping compound annual returns for multiple years and with limited volatility. I’m sure you’ve heard the pitch:
XYZ made 30% returns after 2/20 fees for 20 years before they started this fund. You should invest.
Unfortunately, the human brain is wired to falsely assume that the manager’s past performance, which was probably driven by a different process than the one in the new fund, will somehow translate into performance for the new fund.
But there is something even more corrosive going on behind the scenes. The human brain is accepting the unicorn-like performance as a fact!
[the fund] is down 1.75% so far this year through September, and has booked average annualized net returns of 2.86% since inception in 2007.
2.86% annual returns since 2007? Ouch.
Now, don’t get me wrong, I’m sure RenTech has a sustainable edge that will degrade with the size of their asset base, and maybe this specific fund bested the benchmark by a wide margin, but it is both instructive and humbling to see that the masters of the universe don’t actually control the financial market universe. 35% annual returns with limited risk simply don’t exist in the competitive marketplace (on a large scale, at least). Markets are too efficient. Likewise, even though we may hope there are magical rainbow unicorns in the forest, they simply don’t exist either.
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016).
Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.