Another Promising Fund Goes Under

Several years ago I met a portfolio manager at an investment conference. I had just spoken about investor behavior and dealing with irrational investors when the manager approached me and shared how he incorporates probabilities to help mitigate risk for “irrational” investors. I was intrigued.

It’s All About Probabilities

Investing is a probabilistic endeavor. We don’t know anything with certainty, but we can surmise that there are times when the risk of something is higher than another. Or can we? At the beginning of the year, I believed the probability was high we would see a continued selloff as inflation continued high and then we had a few bank failures in March…with predictions that things were about to get a lot worse. But, in my 24 years as an investment advisor and 10 years as a behavioral finance coach, I have learned that assessments of probabilities can be wrong. And the market often surprises. Despite my opinion and assessment what was probable, the market was up over 7% in the first quarter.

The Probabilities Fund

The portfolio manager I met was very intelligent. His discussion of probabilities and philosophy were different from mainstream equity managers, and I wondered whether such a strategy might be a good sleeve in an investor’s portfolio. Many advisors and investors think this way – which is why there is a lot of money in alternative investments (liquid alts and private placements).

This investment had three primary goals:

  • Provide liquid alternative that will outperform S&P 500 over the long term with low correlation
  • Reduce equity exposure when probability of downside is high
  • Increase equity exposure when probability of upside surprise is high

The objectives sound great. So how has the fund done? Well, over the last five years (thru 3/31/2023) the fund annualized -1.2%. Compare that with the S&P 500 annualized total return of +11.2%. That is significant underperformance! Therefore, it shouldn’t be surprising that this fund liquidated on Mar 31, 2023.

The Big Lesson

The big lesson is that the market can’t be predicted. Even with an intelligent money manager and strategies that consider probabilities, we just can’t get it right. Probabilities can be misleading. The reason is because the market is so complex, it would be near impossible to account for all inputs in a probabilistic algorithm. And there is likely some subjectivity to our analysis – what we think or feel is likely or unlikely to occur.

Over the years I have left a lot of money on the table by trying to anticipate what may come next, even using probabilistic inferences. We all have good intentions, but the market just can’t be treated that way.

Remaining disciplined to a durable and personal investment strategy is often the best approach, irrespective of what we (or “experts”) think is likely or unlikely to occur. It is not comfortable. Sometimes we go against every fiber of our nature of what we feel is the right thing to do. But investing was never about feeling good. It is about making good decisions. That is why I find behavioral finance principles so valuable. They ground me, and in return, help me do a better job helping others.

Related: Why Haven’t Investors Panicked ... Yet?