The other day Josh Brown, one of my favorite social media follows and author of the blog The Reformed Broker, wrote an excellent treatise on Simple vs Complex investment methods. If you haven’t already, go here to read it. You won’t be disappointed.
My first thought after reading this is that Josh hit the nail on the head. I hate jumping on this bandwagon after he already blazed the trail, but my hope is that sharing some of my own experiences with complex strategies will drive this point home even further.
Complex Sounds Better
I used to work with a colleague who believed wholeheartedly in the complexity and interconnected machine that is the global markets. He was tremendous at espousing his views on how if X does this, then Y does that, and Z will go here, and so on….
I would sit in meetings with him and prospective clients while he spun tales of these complex structures. Before you knew it, he had convinced the investor that we were going to own inflationary and deflationary assets. We were going to be long stocks and long volatility. We were going to own the dollar and simultaneously short it. We were going to hedge our hedge and if that doesn’t work, we will just hedge that too.
“Sounds great!” they declared, “let’s do it.”
In practice, this equated to big and long-term piles of cash that were randomly deployed in small allocations to a confusing array of exotic mutual funds or ETFs. Positions were selected and sized with arbitrary considerations. There was no rhyme or reason to it. No sense of balance, proper diversification, or long-term thinking.
It was a complete mess that very rarely resulted in any positive net gains for anyone. Everything was so contradictory that the portfolio just chased itself in circles and never went anywhere.
The most important part to him and the client (on the front end) was that it sounded good. People want to believe there is some magic going on behind the scenes that you are employing as an advisor to try and beat the market.
Shockingly, complex jargon and mediocre execution doesn’t equate to reliable returns.
Complex Is Expensive
If you truly look deep at the most complex investment strategies, you will quickly realize that they are all expensive. Obviously, this is touted as an advantage because they are so much more “sophisticated” than their passive peers (insert sarcasm font).
Quant-driven hedge funds – 2% management fee and 20% of profits.
Actively managed mutual funds – expense ratios can easily reach well over 2% (and include sales charges).
Event-driven ETFs – likely approaching a 1% fee or even higher in some cases.
These additional layers of fees eat into your profits and are an important part of why these funds often underperform their benchmarks. If you are going to pay up for a unique strategy, make sure you understand its value proposition and have clearly weighed the pros and cons of this decision.
Complex Can Be Frustrating
Many investors fall for alternative solutions like managed futures, volatility hedging, and other strategies touted as risk averse or non-correlated. Even when these tactics are backed by strict rules or data-driven models, they can often fail in spectacular fashion.
Just because something looks good on paper, doesn’t mean it’s going to translate into the real world. This is particularly true when you are dealing with esoteric asset classes or unconventional trading methods.
The problem with non-correlated strategies is that they become frustrating when they zig as the market zags. If this occurs for a long enough period, you will likely abandon that effort at the tail end of the cycle – just before it really starts to perform.
The Bottom Line Strategy: KISS
I’m not here to pass judgement on the best investment strategy. Everyone has their own philosophy that works well for them. However, in my experience, the KISS rule has always kept me out of trouble and led to better returns.
KISS = Keep. It. Simple. Stupid.
A simple strategy is one you are more likely to understand and stick with through good times and bad. It should be low cost and allow you to sleep well at night knowing the embedded risks and opportunities well ahead of any specific event.
For me, that means using efficient tools like ETFs with a more traditional asset allocation structure. I like to employ core holdings as portfolio building blocks and add tactical positions that can be shifted to reduce risk or take advantage of new opportunities.
Witnessing the effects of overly complex methods was one of the best learning experiences of my life. If you don’t know what you own and why you own it, get out and move on.
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