In his book The Wisdom of Crowds, James Surowiecki uncovers a striking revelation – large groups of non-experts can exhibit a collective intelligence that often surpasses the knowledge of individual experts. Surowiecki provides several examples to support his thesis, ranging from jellybean counting competitions, where the average guess is more accurate than most individuals’, to the success of prediction markets in forecasting political events.
The implications of this idea extend to the world of investing, where the collective intelligence of the market is far more efficient at pricing information than most individuals. Rather than try to outsmart the market, our strategy seeks to exploit the behavioral shortcomings of market participants by orienting our portfolios towards high-quality, undervalued stocks with positive price momentum. As the chart below illustrates, stocks scoring high on value, momentum, and quality characteristics have historically outperformed their peers.
Pricing inefficiencies stem from cognitive and emotional biases that affect collective judgement. Value mispricings arise when investors overreact to news, driving prices to irrational levels. Momentum’s outperformance is explained by the market’s slow reaction to new information (anchoring bias) and investor herding. Quality companies, characterized by their durability and stability, are better equipped to withstand economic downturns.
These characteristics not only add value on a stand-alone basis, but also offer significant diversification benefits through integration. Value and Momentum, for example, are negatively correlated. This intuitively makes sense, as value stocks are likely cheap because they’ve recently declined in price, and vice versa. By integrating the three approaches, we harness their return potential while reducing the volatility of excess returns.
By combining the principles of value, momentum, and quality investing, we aim to capture the best of what the market has to offer. Value investing capitalizes on market overreactions, momentum investing on the continuation of trends and market underreaction, while quality investing offers stability and consistency. And that is just the beginning. There is a second half to our approach which incorporates sentiment and insights from best-in-class asset managers. We further add value in how we construct our portfolios, manage risk, and execute trades, all of which we would be delighted to share with those interested. This multifaceted strategy, we believe, positions us uniquely to capture the full spectrum of market opportunities.
