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Oppenheimer Fundamental Alternatives Fund – The Market Knows More Than Ms. Borré

I recently came across a video advertisement for the Oppenheimer Fundamental Alternatives Fund (MUTF: QVOPX ), which is currently headed up by the alpha seeking Michelle Borré. Her pitch revolves around understanding both empirical “hard” data and the human “soft” data to extrapolate information about the future prospects of the market, all while trying to minimize volatility and still produce a solid positive return. This all sounds very appealing, but history has shown that these ideas and, more importantly, being able to anticipate or control them, have largely led to subpar investment performances. In this article , the entire Oppenheimer fund family was examined. The results were not too promising to say the least. Let’s dive deeper and isolate the Fundamental Alternatives Fund to see if there is any merit to the statements being made in their video. What we will show, not only empirically but also theoretically, is that Oppenheimer’s idea of being able to evade volatility or provide a superior understanding of human nature that they can extrapolate any sort of “alpha” from it is built on a false foundation. Let’s start by looking at their past performance based on a comparison to their Morningstar assigned benchmark. The alpha chart below shows their annual alpha (relative performance to the benchmark) since inception in 1999. Click to enlarge What is noticeable is that, overall, the historical performance has not been great. In 13 out of the 17 years, the fund had a negative alpha. On average, it lost by 2.36% per year. If we look at the performance since Ms. Borré took the helm (Nov. 2011), we can also see that she has also not provided superior performance with only 1 out of 4 years showing a positive alpha. Past results are not indicative of the future, but there is nothing substantial here that gives us a promising outlook on this fund’s ability to do what they say they are going to do. This is where theory can provide a more robust explanation of why we would not expect this fund, or any actively managed fund, to turn around in terms of their performance. First, there is the whole idea of trying to minimize volatility while still providing above average returns. Within equities, this involves hedging particular risks associated with stocks, and trying to pick next winner. For example, in its more simplistic form, if we wanted to gain exposure to the financial sector but wanted to remove the risks associated with the financial sector (Beta), we can go long a particular financial stock that we thought was undervalued and short a particular financial stock that was overvalued. We can even go broader and go long a group of financial stocks and short a group of financial stocks. By being long and short within financials, we are removing the systematic risks associated with financials while having a positive exposure to what we think will go up and a negative exposure to what we think we will go down. We are essentially doubling down on our ability to forecast the future. The problem with this approach is that it is very unlikely that Ms. Borré, or anyone, knows any more about a particular stock than the combined information of the thousands, if not millions of investors watching that stock. Remember, the price of a particular stock at any given time represents millions of estimations about the particular value of a given company not only based on information that is currently public, but also future forecasts and even some insider knowledge as well. To be successful in outperforming a market consistently over time, you must have better estimation faculties, quicker access to information, or have inside information, and then exploit that information in a cost effective way. As Mark Hulbert said in his 2008 NY Times article , “the prescient are few”. The chart below summaries the study Hulbert discussed in his article. Click to enlarge This idea also applies to trying to understand human nature or behavior and extrapolate information that can successfully be exploited in investment strategies. It should go without saying that not all investors are trading based on rational expectations as traditional economic theory suggests that people do. We can all think of someone in our life that makes decisions based purely on emotion with no logic at all. We are humans, not robots. The questions is whether or not we can anticipate these events (such as the herding effect we see with large overall movements in markets) and be ahead of anyone else that is trying to take advantage of the same exact “animal spirits” within the markets. Once again, we fall victim to our own estimation limitations as well as not having all and complete information. It is always easy in hindsight to say, “well that looked like irrational exuberance,” but very few actually successfully capture that irrationality in an investment strategy. I published an article that highlighted investment strategies that are based on exploiting behavioral biases. There is no empirical evidence that these strategies have been successful in that endeavor. There is an entire support team at IFA that helps put together these articles. Oppenheimer has been successful in building up their investment assets over time. We have shown that this success is largely built on advertisements, such as the one with Ms. Borré explaining her strategy. While it all sounds very good, a successful implementation of these ideas is not supported by empirical research, has not worked in the past AND more importantly, is not expected to work in the future. Market prices are moved by news and news is random and unpredictable. Let go of the idea that you or a manager you select will have wisdom greater than the market. Just index and relax. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

‘Go For Growth’ Still A Sound Strategy In Today’s Market

Stocks perceived as mitigating the effects of market volatility were popular among investors in the first quarter. Big swings in equity markets drove a flight to quality that benefitted dividend-paying sectors such as Utilities and Telecommunication Services (which were the two best-performing sectors in both ACWI and the Russell 3000). We largely have avoided those sectors due to their elevated valuations and the fact that we don’t believe they offer the growth possibilities that are necessary to generate long-term returns. While some high-profile growth stocks trade at triple-digit P/E valuations today, the reality is that the vast majority of growth stocks do not, and we do not believe it is worthwhile to examine what is happening with the growth story. The case for growth stocks in a low-growth world is relatively straightforward. All else being equal, companies that are capable of delivering above-average growth in a low-growth world should be rewarded by investors over time. However, in investing, all else is rarely equal. A high-growth stock at an unsustainably high valuation can be just as risky as – or even more risky than – a company that is in secular decline. 2015 was the best year since 2009 for major U.S. growth indices (e.g., Russell 1000 Growth, S&P 500 Growth) versus their value counterparts (e.g., Russell 1000 Value, S&P 500 Value), so it makes sense to take a deeper dive. The median growth stock trades at a similar valuation (on both an absolute and relative basis versus non-growth stocks) to where it started 2015. For example, the median P/E of Russell 1000 Growth stocks that have no weight assigned to the Russell 1000 Value traded at a next 12-month P/E of 19.4 at the start of 2015. This group of stocks entered 2016 with a very similar next 12-month P/E of 19.5, and ended the first quarter at 19.7. Absolute valuations for this group as a whole are not cheap, and therefore, risks associated with coming up short of investor expectations can be high. However, the premium for these high-growth businesses versus the rest of the Russell 1000 is well within historical norms (see chart below). Against this backdrop, we continue to seek opportunities to own well-positioned, growth-oriented businesses with valuations that offer attractive compensation for the risks taken. The number of such opportunities might be fewer than earlier in the current market cycle, but we believe a selective and active approach to investing can maximize the likelihood of finding such companies today. Click to enlarge Investing in companies that can grow their earnings at rates above the trend in broad economic growth is particularly important in today’s slow-growth economy. As an illustration, we’ve taken returns in the U.S. equity market on a rolling 10-year basis and broken them down into how much came from earnings growth and how much came from changes in the P/E multiple (i.e., multiple expansion or contraction). Beginning in 1970, it has been earnings growth that has been more consistent and stable most of the time (see chart below). Historically, earnings growth has been a more reliable contributor to the returns we get as investors than multiple expansion. Click to enlarge While there certainly are periods in which multiple expansion drove or provided a boost to returns, changes in multiples have been quite volatile. In the 1980s and 1990s – when multiple growth helped returns – the market was coming off some attractive starting valuations and had a backdrop that was favorable for rising valuations. As a result, there was solid multiple expansion. But before that – and, more importantly, recently – not only could investors not rely on multiple expansion, they also had to deal with multiple contraction. This is one illustration of why we believe it is particularly important right now to focus on companies that are capable of growing their earnings on an individual basis, which, in our view, puts investors in a much better position to generate positive returns. Past performance does not guarantee future results.

Stock Market Values – How To Value A Company With No Earnings

Is it just a case of irrational exuberance? Not necessarily. Traditional discounted cash flow analysis is a useful tool when it comes to evaluating financial assets, but it has its limitations. One aspect of investing that DCF analysis ignores is management’s flexibility. They can delay bringing a product to market, or expand its production to meet an unexpected surge in demand, or shift how their facilities are used – perhaps to produce a different kind of product. This kind of flexibility has real value. To capture this value, we use option-pricing methods to supplement traditional valuation. An option is an asset that can go up, but is limited to the downside. If management possesses a patent on a new drug, that patent has value even though it’s not producing cash right now. The upside may be huge while the downside is limited to the cost of bringing the medicine to the marketplace. Click to enlarge Call option pricing. Source: Wikipedia This is also why many tech companies seem to persistently carry such high valuations. The market is putting a high value of its potential growth, and the flexibility management has to pursue different approaches to its business. Putting a value on this kind of asset – management flexibility – is difficult, but it can be done. It depends on the cost of exercising the flexibility, the potential upside a change could realize, the amount of time management has to make the decision, and how volatile conditions are. The more volatile things are, the more these options have value. These values can all be quantified in a pricing model. Click to enlarge Black-Scholes Option Pricing Formula. Source: Wikipedia In practice, this involves a lot of assumptions about stock prices and strike prices and market volatility run through an analytical model with decision points and normal distributions. Additionally, the real world will insert complexities that our models can’t accommodate. Nevertheless, options methodology is essential for understanding why some money-losing companies still have high market values and why some profitable companies seem so cheap. Today, it seems the market is putting a lot of value on the options that Internet-media companies like Amazon (NASDAQ: AMZN ) and Netflix (NASDAQ: NFLX ) possess. It’s not necessarily irrational just because you don’t understand it. Sometimes, what is unseen is more important than what is seen. It’s all in the options. Disclosure: I am/we are long THE MARKET. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.