09-14-2021: What is "Anchoring Bias"?
I was speaking with a client earlier in the week about the 2021 returns for our Turner Quant Advantage (TQA) portfolio model. He had questions about how well his portfolio has done for the year in comparison to the S&P 500. It was a great question and I will share my answer with you in tonight's blog.
Below is a chart of the TQA model from the beginning of 2021.
Turner Quant Advantage for 2021
As you can see, the momentum from 2020 (where the portfolio was up 48%) continued into the new year. At the top in February, the gain was almost 10%. Right now, the TQA model is up about 5% for the year. And, yes, when comparing this year's performance to last year’s 48% gain, the 5% gain seems underwhelming.
But that’s only looking at one aspect of the market.
Below is another chart and if the only thing you cared about were the gross returns, then you would hate the how following this well-known and highly touted fund has performed in the same timeframe.
This is the YTD chart for the famous ARK Innovation Fund (ARKK), the flagship ETF of Cathie Wood. From its high in February, ARKK is down more than 26%. For the year, it’s down more than 3%.
That’s terrible, right? After all, the market is up almost 20% this year. But, that is not the whole story. Wood's ARKK fund has generated some amazingly strong returns in the past and to consider the current year as the only way to judge this fund, would be short-sighted and definitely not realizing the longer-term performance potential. I am not knocking or recommending ARKK. I leave that up to you to do your homework, but I am using this as an example of a well-run fund struggling to compete with the S&P 500 over a very short period of time.
A lot from investors have blinders on and only focus on a small subset of data. In this case the small subset of data is “year-to-date” with little or no focus on a longer timeframe; no focus on risk; no focus on increase or decrease in volatility. They just focus on the short-term performance of the market and ignore all other data that can have a dramatic impact in net total return.
This is a good example of what is called “anchoring bias”. There is a relatively new area of economic science that examines the different cognitive biases that affect investors and cause them to make investing decisions that aren’t always in their best interest. In this case, it’s called “anchoring bias” because some investors “anchor” their perspective to only a particular date or one particular index and ignoring most other data that could negatively or positively impact net total return; and significantly so.
In my weekly letter, I share the following proprietary chart that tracks the “Turner Capital Total Market Index”. The TMI looks at the four major averages and combines them to get the best view of what “the market” is doing at any point in time.
Without getting into a lot of the details on this chart, take a look at the yellow band. This is called the “Volatility Rating Band” (VRB). It measures the risk in the market at any period in time. You’ll notice that the VRB was very narrow in 2018, 2019, and early 2020. As the year progressed, the VRB expanded until it was at its peak during the first several months of 2021.
Simply stated, the wider the VRB, the more risk of a major correction there is in the market. The narrower the VRB, the less risk there is in the market.
As a fiduciary, my clients have given me a dual mandate to manage their money. The first mandate is to generate a positive return when the opportunities support owning high-quality stocks and ETFs. The second mandate is to protect my clients’ downside if risk becomes overly elevated.
That’s it. Every investment decision is made from this dual mandate perspective. As risk grew substantially this year, it was prudent to tighten stops, limit risk exposure and protect client assets. As risk has begun to narrow, we have expanded our stop settings to capture the maximum gains possible while still being aware of market risk.
Does anyone think that Cathie Wood is all of a sudden a bad investor because ARKK has dropped in price over the past several months? I certainly do not. It will take a lot more than a short-term assessment of the fund to draw any conclusion of longer-term performance capability.
If you’re only looking at YTD numbers, you’re missing the whole story. What if I told you that since the beginning of 2020, TQA has returned 55% and had a drawdown of less than 7% including during a 30%+ drop in the market? Does that fact require a change in perspective (anchoring) a little?
No one knows what will happen in the future. Past performance is no guarantee of future returns, but what we do know is the data are absolute and will always tell us whether to be aggressively investing or holding more cash as we continue to operate with the same dual mandate that has served our clients well for many years. We will continue to measure the market rather than trying to guess what’s going to happen next.
We strive to keep our portfolios positioned to avoid major downside risk and open to upside gains as the market fluctuates from bullish to bearish trends over time. We do not 'anchor' our efforts to only one measuring stick. That would be a disservice to our clients if we did.