A Secret Little Formula

February 09, 2023

2022 was not a great year in the stock market. You don’t need me to tell you that. Everyone knows. Stocks were down. Bonds were down. Cash was unhelpful in an inflationary environment. Old news. No fun.

But not everything was down. Commodities did well. The Dow Jones Commodity Index was up ~21% on the year.[i] Some alternatives did very well. Managed futures particularly. AQR’s Managed Futures Strategy Fund was up 35%.[ii] On a year when the S&P was down 18%.[iii] Blackrock’s ETF based on the stock market in Turkey was up 106%.[iv]


Please do not read this as an inducement to buy, sell, trade, or do anything else with commodities, managed futures contracts, stocks in a particular country, or any other security/derivative. That sentiment should be made clear in the following paragraphs. But I need you to read that in this fancy italicized print here first.

The natural inclination of an investor is to chase performance. That is, you look at your portfolio and you see some stuff performed relatively well last year and other stuff performed horribly. Or perhaps it’s all just bad and horrible. 2022 was one of those years. Holding onto the bad and horrible stuff isn’t any fun. Suppose you heard someone at a party say something like “my managed futures portfolio was up 35% last year!” or “I doubled my money in 2022 investing in Turkey!” You begin wondering if perhaps it would be best to get rid of some of the junk that lost you money last year and buy MANAGED FUTURES! and TURKEY!

If you have read this blog for any length of time you know this is a bad idea. The common parlance is selling low and buying high – the cardinal sin in investing. Getting rid of that junk in your portfolio to buy MANAGED FUTURES! and TURKEY! sounds much better than selling low and buying high. And it feels sensible. Something fun to talk about at parties. You don’t know what MANAGED FUTURES! are (I barely do), but they sound like something a smart person would buy. You probably can’t name a company represented in Turkey’s stock market (I can’t*), but you’ve tasted baklava. Betting on the folks that came up with baklava seems sensible. Right?

It is still selling low and buying high. Still the cardinal sin.

I want to focus less on individual investors and more on financial advisors today. I’ll let you in on a secret little formula some advisors use:

(a) Prospective clients want to see outperformance


(b) Show them outperformance

Financial advisors like bringing on new clients. That’s part of the job. The easiest way to bring on a new client is to show them a portfolio that outperformed their own over some random time horizon. Here is how a conversation between an advisor using the “secret little formula” and a prospective client might go:

ADVISOR: “May I see a recent statement for your account?

PROSPECTIVE CLIENT: “Sure, here it is.

ADVISOR: “I see, it looks like you were down 18% last year.”

PROSPECTIVE CLIENT: “Yes it was a tough year. The markets sure are volatile.”

ADVISOR: “Our portfolio with a similar allocation was up 12%.”

PROSPECTIVE CLIENT: “Where do I sign?”

Ok the where do I sign bit was a tad facetious, but the rest of the conversation is not uncommon. Perhaps the prospective client really had an allocation that made no sense leading to unreasonable underperformance. If your portfolio’s benchmark was up 12% and you were down 18%, you may have a problem somewhere.

But assume your portfolio was down 18% last year and the benchmark was down 18%, give or take a few percentage points. And now you’re confronted by an advisor showing a positive 12% return on the year. How did the advisor pull that off?

The honest method is the advisor genuinely outperformed by a massive margin. That happens sometimes. I don’t believe it can be consistently repeated. There is a lot of research indicating that is the case. Reallocating your portfolio to chase the manager who performed best over the past year is another iteration of performance chasing. And we have already established performance chasing is not good.

The other way is the dishonest method. That is when an advisor takes a look at what has performed well recently and adds a bit of that to his model portfolio. Then he runs a back test to show how his new and improved portfolio performed in 2022. Add a little MANAGED FUTURES! and TURKEY! to the portfolio and Voila! 2022 performance looks great. Perhaps instead of asking where to sign, the fictitious conversation above continues like this:

PROSPECTIVE CLIENT: “Wow, really? How did you manage that?

ADVISOR: “Well we believe in diversification while taking advantage of the opportunities in front of us. We sensed a downturn on the horizon after the wild runup of 2021 and allocated a portion of the portfolio to managed futures, which are often uncorrelated to conventional assets in a downturn. We also watched Turkey’s central bank slash interest rates even while inflation ran amok, so we expected the Turks would be forced to store their wealth in their stock market to hedge the Lira’s loss of purchasing power. That turned out well for us as that position returned over 100% on the year.”

PROSPECTIVE CLIENT: “Wow, you’re really smart!”

ADVISOR: “Well we have a great team and we work very hard and take the management of our clients’ assets very seriously.”

PROSPECTIVE CLIENT: “Where do I sign?”

None of this (purely hypothetical) advisor’s clients actually outperformed. He added MANAGED FUTURES! and TURKEY! after the runup. He performance chased. Buying high is the common parlance. Buying high is not ideal. But it sure looks good in a back test. And a back test is what he shows the prospective client. When those MANAGED FUTURES! and TURKEY! positions were added to the portfolio is conveniently omitted.

We do not think this is a good way to run a business. None of our portfolios were invested in MANAGED FUTURES! or TURKEY! last year. I am quite proud we don’t own those assets. An advisor taking pride in not owning two of the best performing assets of last year may sound strange. But no one could have known in 2021 that MANAGED FUTURES! and TURKEY! would be the winners of 2022. And we certainly aren’t going to window dress our portfolios with expensive assets after the runup just to make ourselves look good in a back test. We advise people not to performance chase because we don’t do it ourselves. We avoid complex financial derivatives contracts (MANAGED FUTURES!) and bets on individual countries (TURKEY!) anyway. We have our long-term strategies, and we stick to them. We’re less focused on performance – particularly over some arbitrary time period – and more focused on positioning our clients to be successful in the long term as they define success.

Performance often doesn’t tell the whole story.

Sean Cawley, CFP®

*I checked the holdings. Never heard of any of those companies. They sure performed well in 2022, though.

Neither asset allocation nor diversification guarantee against investment loss. All investments and investment strategies involve risk, including loss of principal.

Content here is for illustrative and educational purposes only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy. Results will vary. Past performance is no indication of future results or success. Market conditions change continuously.

This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.

[i] YCharts, DJC Total Return Level, 12/31/2021 – 12/31/2022

[ii] YCharts, AQMIX Total Return Level, 12/31/2021 – 12/31/2022

[iii] YCharts, SPX Total Return Level, 12/31/2021 – 12/31/2022

[iv] YCharts, TUR Total Return Level, 12/31/2021 – 12/31/2022