Beating the market constantly is an IMPOSSIBLE MISSION

Wesley Gray, after serving as a captain in the United States Marine Corps, earned an MBA and a Ph.D. in finance from the University of Chicago, where he studied with Nobel laureate Eugene Fama. Gray has fought to bridge the research gap between academia and industry, which is why he founded Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education.

The study, conducted by Wesley Gray, founder of asset management group Alpha Architect, posed the question: “If God is omnipotent, could he create a long-term active investment strategy fund that was so good it could never be fired? ? “

Gray calculated five-year “anticipated” returns for the largest NYSE / NASDAQ / AMEX companies. considering its common shares since 1927, excluding those without a full 60-month history. Analyzed the returns gross and total returns, including dividends, and created decile portfolios based on the five-year compound annual growth rate (CAGR), rebalancing portfolios every five years, so the first portfolio was built on January 1, 1927 and it was maintained until December 31, 1931; the second portfolio was built on January 1, 1932 and was maintained until December 31, 1936, and so on. The objective was to capture the results associated with a long-term investor (with holding periods of 5 years). Returns are weighted by market capitalization.

In the chart below, Decil 10 portfolios represent value-weighted portfolios ranked by performance to five-year high-yield futures and Decil 1 portfolios represent value-weighted portfolios ranked by future worst-performing five-year returns.

As expected, a portfolio made up of the names that have the best 5-year performance achieves the best profitability in the period. But nevertheless, the manager would encounter a capacity limitation and it would become the owner of the entire market, with an annualized profitability of 29.4%, a volatility of 22.41% that would be higher than that of the S&P, with a Sharpe ratio although higher than 1, but much better than the 2+ of some alternative funds, but it would have a maximum loss (max drawdown) of more than 75%.

What if God could create a hedge fund?

We would take advantage of that forecast of the Gods and make a portfolio where the winning positions and the losers would go short, with monthly rebalances and the results would improve significantly, with the Sharpe increasing, volatility drops and profitability increases, however, there is still a maximum of -47.28%.

But It is clearly confirmed that consistently outperforming the market in the long term is not possible even when there is “someone” who has full predictive ability.