SweetSpot® Investments LLC

Research

SweetSpot began trading in December 1998 based on information provided by Morningstar and Lipper as reported in the Wall Street Journal. Morningstar and Lipper had conducted research showing that unloved funds tend to outperform other funds and the market over time. Their findings were confirmed by Evergreen Capital Management LLC in a 2005 study showing that sectors with negative cash flows tend to produce market-beating returns in the future.

The validity of the SweetSpot approach to investing was further buttressed in 2010 by investment-research firm TrimTabs. The firm published a study, Using Equity ETF Flows as a Contrary Leading Indicator. The clear finding was that investment sectors experiencing capital outflows tended to outperform the market by a significant margin going forward.

The sweet spot as it applies to stock investing was described by Harry Dent in his book, The Next Great Bubble Boom (pp. 211-212). Discussing returns and risk measures for broad investment sectors from 1975 to 2001, Dent wrote: “[W]e can see… the advantage to investors of having been in the best asset classes when they were leading. Note that not only are the average annual returns very high when a sector is leading, but the risks are relatively low and sometimes very low. This violates the basic principle that higher returns entail higher risks. Over time that is true, but when an investment sector is in its ‘sweet spot’ you get the highest returns and the lowest risks. But these periods typically last only three to six years.”

A further review of the literature shows nothing but support for the SweetSpot approach to investing. , as summarized below. It shouldn’t be surprising that people have a hard time relying on their wits to achieve satisfactory investment results. The list of hard-wired handicaps they must overcome is long.

A 2007 study by Standard & Poor’s (S&P) found that for the five years ending on December 31, 2006, only 13.2 percent of large-cap funds, 9.9 percent of mid-cap funds, and 10 percent of small-cap funds maintained a top-half ranking over five consecutive 12-month periods. Just 3 percent of large-cap, 2.5 percent of mid-cap, and zero percent small-cap funds maintained a top-quartile ranking during that period.

More-recent S&P research on this topic, published in 2011, 2012, and 2013, is consistent with previous findings. According to S&P:

  • Very few funds can consistently stay at the top. Out of 703 funds that were in the top quartile as of March 2011, only 4.69% managed to stay in the top quartile over three consecutive 12-month periods at the end of March 2013. Further, 3.35% of the large-cap funds and 6.08% of the small-cap funds remain in the top quartile. It is worth noting that no mid-cap funds managed to remain in the top quartile.
  • For the three years ended March 2013, 16.57% of large-cap funds, 14.22% of mid-cap funds and 23.05% of small-cap funds maintained a top-half ranking over three consecutive 12-month periods. Random expectations would suggest a rate of 25%.
  • Looking at longer-term performance, only 2.41% of large-cap funds, 3.21% of mid-cap funds and 4.65% of small-cap funds maintained a top-half performance over five consecutive 12-month periods. Random expectations would suggest a repeat rate of 6.25%.

Other studies have found that most individual investors fare much worse than their already sub-par mutual funds.  How can that be?  Chalk it up to the human tendency to buy in at a high price and sell out at a low one…

Chasing Performance Isn’t Just for the Retail Investor

According to a 2004 study, The Selection and Termination of Investment Managers by Plan Sponsors: The institutional sponsors of investment plans hire investment managers after they earn large excess returns up to three years before they are hired. However, this return-chasing behavior does not deliver positive excess returns thereafter. Post-hiring excess returns are indistinguishable from zero. On the other hand, plan sponsors terminate investment managers after underperformance, but the excess returns of these managers after being fired are frequently positive. If plan sponsors had stayed with fired investment managers, their excess returns would be larger than those actually delivered by newly hired managers.

Losing Money May Be More Painful Than You Think

Losing money may be intrinsically linked with fear and pain in the brain. In a 2007 Wellcome Trust study, researchers showed that during a gambling task, losing money activated an area of the brain involved in responding to fear and pain.

From the Best and the Brightest of All Time:

“Excess generally causes reaction, and produces a change in the opposite direction, whether it be in the seasons, or in individuals, or in governments [or in financial markets].”

Plato (428-348 BC)
Philosopher and mathematician

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“Fortune turns round like a millwheel, and he who was yesterday at the top, lies today at the bottom [and vice versa!].”

Miguel De Cervantes (1547-1616)
Spanish novelist, poet, and playwright

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“This time, like all times, is a very good one, if we but know what to do with it.”

Ralph Waldo Emerson (1803-1882)
Philosopher and poet

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“I do not pretend to know what many ignorant men are sure of.”

Clarence Darrow (1857-1938)
Lawyer and civil libertarian

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“It was never my thinking that made me money but my sitting tight.”

Jesse Livermore (1877-1940)
Legendary investor

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“Everything should be made as simple as possible, but not one bit simpler.”

Albert Einstein (1879-1955)
Theoretical physicist and philosopher

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“Buy when everyone else is selling, and hold until everyone else is buying. This is not merely a catchy slogan. It is the very essence of successful investing.”

J. Paul Getty (1892-1976)
American industrialist

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“If you want to have a better performance than the crowd, you must do things differently.”

Sir John Templeton (1912-2008)
Investor and philanthropist

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“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

Warren Buffett
Legendary investor

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“The simple fact is most people just do not have brains suitable for investing.”

Douglas French
President, Mises Institute

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“When the tide of overpriced assets goes out, it will be revealed not only who is not wearing swimming shorts, but also who has a small pension!”

Jeremy Grantham
Investor and Chairman of the Board, Grantham Mayo Van Otterloo (GMO)

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See also: Annotated SweetSpot Bibliography.