Practical Applications of Where’s the Beef?

Abstract

In Where’s the Beef? from the Special 30th Anniversary Issue of The Journal of Investing, authors Rob Arnott, Amie Ko, and Lillian Wu (all of Research Affiliates) explore why so-called smart beta investing strategies fail to produce the real-world excess returns that academic studies say they do—leaving investors to ask, “Where’s the alpha?” The authors say the fault lies in the human tendency to base future expectations on past experience, which leads investors to wrongly assume that past performance predicts future results. Even seasoned professionals commit two of the biggest mistakes in investing: performance chasing (betting that recent high performance will continue in future) and data mining (using quantitative analysis to look for past market behavior patterns that aren’t really there).

The authors detail several increasingly common dysfunctional industry practices stemming from performance chasing: p-hacking, noise trading, fad chasing, and nowcasting. These lead industry professionals and academics to chase past performance of quantitative models and strategies (not just past asset performance), ignore the effects of transaction costs, and sign off on the underfunding of pensions because of excessively optimistic performance expectations. The authors then suggest ways in which researchers, investment professionals, and investors can fix or protect themselves from these problems.