Where Research Meets Reality: Our Core Investment Beliefs
Gerstein Fisher’s investment approach is built upon a foundation of four key investment beliefs about markets and investor behavior. Rooted in time-tested academic theory, these beliefs also pass the important test of real-world applicability. We know this because they have formed the basis for our investment strategies for 20 years.
Belief #1: Markets are efficient, but investors are human.
What it means: We believe that while investment markets are mostly efficient, they’re not perfectly efficient; therefore prices are not always correct. A key reason for this is the fact that investors are human beings subject to emotions and judgmental biases, such as the tendency to extrapolate recent performance of a stock or an entire market too far into the future, or to wrongly equate a good company with a good investment irrespective of price.
The good news in this is that, when some investors base their investment decisions on sentiment, they create potential profit opportunities for those who instead base their decisions on the logical interpretation of facts and information.
How we apply it: Employ a rules-based, quantitative approach designed to attempt not only help our clients avoid the potential pitfalls of emotional investing but to also potentially capitalize on common investor behavioral biases that influence market returns.
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Belief #2: Risk explains returns.
What it means: Put simply, we believe investors need to incur risk to earn returns. (There’s no “free lunch” in investing.) In our view of the world, returns of financial assets are fueled by multiple sources of risk. Size is just one example: history has shown that investors in smaller-capitalization stocks are compensated for the higher inherent riskiness of small companies in the form of greater returns over their larger counterparts.
If an investment portfolio’s return can be explained by its exposures to various identifiable risk factors, investors can also structure portfolios in such a way as to pinpoint the exact exposures to the risks they want—while avoiding those risks they don’t want.
How we apply it: Engineer portfolio “tilts” (overweights) toward risk factors that empirical research has shown offer investors enhanced return over a market index. This approach rhymes well with our belief in the general efficiency of markets—we think investors are better served collecting risk premiums than attempting to outsmart the market.
Belief #3: Structure drives performance.
What it means: Asset allocation is important. Time and again, even the best stock-pickers have had their value-added swamped by an incorrect or ill-timed asset allocation call. Research supports the assertion that historically, broadly globally diversified portfolios have delivered higher risk-adjusted returns than those concentrated in fewer asset classes.
How we apply it: Build globally diversified portfolios with tilts toward specific risk factors—not individual asset classes, countries or currencies. This differentiated approach represents a progression from traditional “style boxes” and provides our portfolios with an added dose of diversification by virtue of the fact that many of these risk factors have historically exhibited low cross-correlations.
Belief #4: Careful cost and tax management can increase returns.
What it means: With all the uncertainty inherent in global investing, we believe investors are essentially leaving money on the table if they don’t attempt to manage what they can control: namely, taxes and costs. Research has shown that active tax management can add a 1% benefit per year on an after tax basis 1 compared to the average 1.3% tax cost paid annually by investors in mutual funds listed on US exchanges 2 – or a net benefit of 2.3%.
How we apply it: Treat taxes as a transaction cost and engineer tax efficiency directly into our investment strategies. Our quantitative approach allows us to assess the tax and cost impacts of proposed trades before they are executed. We also engage in active tax loss harvesting to help our clients lower their overall tax bill.
1 Arnott, Berkin, & Ye (2001)
2 Maymin & Fisher (2011)