Is There A Secret To Beating The Market?

Blending together assets/strategies with different attributes, correlations and expected behaviors plays a huge role in how I construct portfolios. This is something I've been doing and writing about for ages. The blending, when done effectively, can help smooth out the ride for clients which is a high priority for me.

Forget that though. What if all someone cared about was beating the market, regardless of the volatility, regardless of the occasional, painful drawdown? How could someone go about that? Sidebar: this post is not going where you think it's going. If beating the market was the only thing that mattered to someone, chances are they would not go heavy into utilities and consumer staples. These sectors tend to have lower volatility than the broad market, higher yields and are kinda sorta counter cyclical in terms of (hopefully) having defensive attributes to help soften the blow as was the case in 2022. 

It would make sense to look for alpha opportunities in only certain sectors including technology and consumer discretionary. Yes, there are stocks in every sector that outperform the broad market but what this is about is adding beta. Tech and discretionary have higher betas and as sectors, have the tendency to go up more when the market is going up and down more in declines.

You can decide for yourself if there's enough there to be a tendency or not but in the time studied, the SPX compounded at 14.37% versus 16.60% for discretionary and 20.34% for tech. With all that in mind, I wondered what a portfolio that was 50/50 tech/discretionary would look like versus the S&P 500. That mix should outperform with a lot more volatility. 

It certainly did outperform. Is that a lot more volatility? It is noticeably more volatility but a little less than I expected. The 50/50 mix was down 32% in 2022 versus 18% for the S&P 500 which is a dramatic difference. In the period studied it outperformed in 13 out of the 16 years sampled. 

The idea of tech and discretionary outperforming has merit (disclaimer it's not infallible and not the point of the post). Back to the idea of the power of blending, I wanted to mix in an alternative strategy to see if I could equal the volatility of the S&P 500 but outperform it with these two same sectors.

The standard deviations are almost identical but Portfolio 3's CAGR is 201 basis points higher than the S&P 500. The max drawdown though was much larger. 

The point of today's post is to offer a simplistic example of how I think portfolio volatility can be managed. I have no secret for outperforming the stock market. Over a long period of time, an investor who is at least ordinary will have years that they lag and years that they lead. I think it is far more constructive to manage to a smoother ride which I think is more realistic than "beating" the market. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.