BijaAdvisors

Better Decisions, Better Results

Seeds of Thought
Cognitive Science Meets Investment Management

Issue 15-7
March 2, 2015

This is Your Wake Up Call

Ive been advocating a long US equity position for more than 2 years. There are a whole host of factors
that continue to be supportive of higher equity prices about which I have been writing for months now.
Over the past week, I have given speeches, made presentations and argued my case face-to-face with a
wide variety of audiences. While I have found people to be almost unanimously receptive to the
reasoning, the great majority are reluctant to completely accept it. Even those who are long dont seem
to want to believe there is a solid fundamental case to support it. To be honest, Im not surprised that
very few people share my enthusiasm for equities.
Thing is, Im not merely suggesting that investors should be overweight stocks, I believe they need little
more than just two components in their holdings, large cap US equities and back-end US Treasuries.
Yes, this moment is made for modern portfolio theory, and its important to understand how that puts our
businesses, our careers and the investment industry as a whole, at risk. Thats why it is the topic for this
edition of Seeds of Thought.

Blinded by Our Own Bias

Equities are the very epitome of beta investing. The returns of just about everything else are typically
compared to those of simply holding the S&P 500. What that means is for everyone charging
management or performance fees, in order to justify the additional cost to customers, we must
outperform by at least that much. After all, no one in their right mind would pay a manager to simply
maintain a portfolio that mimics the returns of something that can be obtained practically cost-free. As a
result, investment managers and allocators are inherently incentivized to position elsewhere and are
naturally biased against higher equity prices. Allocators and investment firms regularly seek managers
whose portfolios offer a good hedge against stocks going down. That is, of course, unless stocks are
rallying.
Truth is, investors seek investments that do well regardless of what is happening anywhere else. What
managers fear is underperforming, because that causes AuM to recede and makes new assets harder to
come by. As investment managers, we are competing with each other for assets. As portfolio managers,
we are competing with each other for jobs. As it has become more and more difficult to raise assets and
the job market has become tighter and tighter, participants have naturally become more focused on not
screwing things up, than on outperforming. Risk aversion has taken over.
It makes sense. With returns so low across the board, underperformance is hardly a concern for anyone.
If no one is knocking it out of the park, why take risk? If everyone is bearish equities, why step out of
the pack and go long? You see, at moments like these, the real risk isnt in underperformance, it is in
stepping outside the pack and getting clipped, for if that were to happen you would surely lose either
AuM or your job. Both of which are incredibly difficult to come by these days. In other words, career
!
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Bija Advisors Seeds of Thought

Issue No. 15-7

risk and business risk are real concerns weighing heavily on the minds of market participants and
affecting their behavior accordingly.
It makes perfect sense then to be inclined to position for lower equity prices and higher rates, right?
Wrong.
Think about what caused the drying up of the job market for investment professionals and forced the
compression of fees. Was it a population boom that suddenly flooded the market with highly qualified
people? No. It was the invasion of a whole new class of efficiency experts, with whom none of us can
compete. Their ability to calculate, analyze, execute and service, and at a fraction of the cost it requires
the rest of us, puts us in a precarious position. Im speaking of course about technology. What does
technology do best? Beta.
So, if we cant possibly compete with technology at its own game, we better beat it where it struggles
lower equities, higher rates, chaos, high volatility. Intuitively, it makes sense then that the market
consensus favors lower stocks, but should it? On a quarterly and annual basis since 1928, the S&P 500
has rallied twice as often as it has fallen. When snapped on a quarterly basis, the median year-on-year
return has been 9.0%. While some may worry that we have experienced a 6 year bull run, truth is, 2011
wasnt technically a positive year, but even if you count it, it still wouldnt be cause for concern based
on historical precedence. Also, as of the end of 2014, the S&P had rallied 85% in the five years prior.
Sound like a lot? Turns out it has had a 5 year appreciation of at least that much, 12 times since 1954,
and in the year that followed that performance, it still rallied twice as often as it fell, appreciating an
average of 15% in those 8 positive years. As for rates, many people have used the term long run
average to support their argument for a skewed risk / reward that favors being cautious, but here too the
evidence doesnt seem to support the position. Ive included a few charts for perspective, but at the end
of this piece, so as not to create a distraction.
The fundamental point Im trying to make, is that while you may believe your best hope against beta and
technology lies in lower stocks and higher rates, the odds are stacked against you. However, its even
worse than that.
By positioning against beta and with the rest of the pack, at best you are playing for the status quo from
an AuM and career perspective. If I am correct in my prediction that the real risk for equities is in a burst
higher and that interest rates will not experience a sustainable shift higher, the downside could be
catastrophic for the investment management business. It would mean underperformance, not relative to
other managers, but versus your real competition technology.
The seed I am attempting to plant here is the possibility that our investment risk analysis is being heavily
influenced by our concerns over career and business risk, and ironically it is that very burden that is
pushing us in the direction which actually puts our careers and businesses in the greatest danger. In other
words, higher stocks is where the greatest long-term pain exists for the investment industry as a whole,
and the individuals employed by it, by a wide margin.

Postscript
For those of you who feel the need to have a lottery ticket, might I suggest buying low delta S&P calls,
rather than puts? Also, the most common follow-up questions to my presentations have involved
emerging markets, and that worries me. While it is possible risk assets could also rally if my macro
expectations are met, my argument for higher equities is not based on increased appetite for risky assets.

Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-7

However, the belief that the two are somehow inexorably connected could set many up for the most
costly outcome of all, higher US stocks accompanied by a selloff in risk assets. A very real possibility.

Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-7

Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-7

About the Author

For nearly three decades, Stephen Duneier has applied cognitive science to investment management, and
life itself. The result has been top tier returns with near zero correlation to any major index, the
development of a billion dollar hedge fund, a burgeoning career as an artist and a rapidly shrinking
bucket list.
Mr. Duneier teaches Decision Analysis in the College of Engineering at the University of California
Santa Barbara. Through Bija Advisors' publications and consulting practice, he helps portfolio managers
and business leaders improve performance by applying proven decision-making skills to their own
processes.
As a speaker, Stephen has delivered informative and inspirational talks on global macro economic
themes, how cognitive science can improve performance, and the keys to living a more deliberate life, to
audiences around the world for more than 20 years. Each is delivered via highly entertaining stories that
inevitably lead to further conversation, and ultimately, better results.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America and
Managing Director of Emerging Markets at AIG International. His artwork is represented by the world
renowned gallery, Sullivan Goss. He received his master's degree in finance and economics from New
York University's Stern School of Business.
Bija Advisors LLC
Web: BijaAdvisorsLLC.com
Email: info@bijaadvisorsllc.com
Twitter: @BijaSeeds
Podcast RSS: BijaSeeds
LinkedIn: Duneier
Phone: 805.452.9429

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Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document