By Sergiy Lesyk, director, research and analysis
Burton Malkiel's “A Random Walk Down Wall Street” was enormously influential in investment. It argued that asset prices typically exhibit signs of a random walk and that one cannot consistently outperform market averages. It featured a hypothetical but now almost mythical blindfolded monkey, which threw darts at a list of companies to pick stocks in its portfolio. This portfolio managed to outperform the market index. The book, and of course Malkiel himself, were enormously influential in the move away from active management.
We have followed the monkey’s stellar investment career with some interest and wondered how it would perform in these challenging times. In our latest paper we lifted the veil of mystery on why the monkey performed so well. In essence, the primate’s success is in hands of the human, who weights the stocks picked for the investment portfolio. In the book equal weighting was used, and that was the key to the portfolio's performance.
For the study, we simulated random stock picking in the last two years with equal weighting of the stocks in the portfolio and looked at the average performance of 100 portfolios in the last two years. The chart below shows that our monkey has actually underperformed the market over this period of time.
Source: FTSE Russell as of August 21, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
The reason for this is not that it suddenly ran out of luck or lost its stock picking prowess... it never had any. It is simply that factor exposures of an average portfolio are similar to an equally weighted portfolio which has large exposure to size factor as well as negative factor exposures to quality and low volatility (see chart below).
Source: FTSE Russell as of August 21, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
This combination of factor exposures actually drove down the performance of equally weighted portfolio where the main driver was the size factor tilt. Indeed, the size factor underperformed in the last two years as shown in the chart below.
Source: FTSE Russell as of August 21, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Hiring a monkey to manage your investment portfolio would have been detrimental for your financial health in the last two years, particularly during the most recent COVID market volatility.
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