Resources/Weekly Insights

Volume 13, Edition 12 | May 25 - May 31, 2024

Take Your Portfolio from Middling to Winning

Doug Walters, CFA

What do British cycling and evidence-based investing have in common? This week we discuss how marginal gains can lead to big successes.

Contributed by Doug Walters, David Lemire, Eh Ka Paw, Max Berkovich

Recently, while delving into James Clear’s book ‘Atomic Habits’¹, I was struck by the concept of marginal gains. It was not a new concept to me per se, and having lived in London for a stretch, I was somewhat familiar with the incredible story he narrated about its impact on British cycling. But for some reason, the striking parallels to evidence-based investing had never dawned on me… until now.

If you are unfamiliar, the marginal gains theory promotes the idea that making a series of small incremental improvements can lead to significant overall improvement. Sir Dave Brailsford, who became head of British Cycling in 2002, went all-in on marginal gains. The improvements included everything from painting the maintenance truck floor white to better spot dust to bringing their own mattresses and pillows with them so the athletes could have a consistent sleep experience². The team went from middling to winning, coming home with over half of the cycling gold medals at the 2008 Beijing Olympics.

Evidence-based investors take a similar approach. We are not looking for the long-shot, unicorn investment. Instead, we seek as many ways as possible to consistently tilt the performance scales in favor of our clients. We do not rely on a few big ideas, but rather, a number of strategies, each of which has the potential to add some basis points to performance. Here are but a few:

We do not pick individual stocks. The average stock picker underperforms a passive index. There are better tools available today than back when stock-picking was king.
But, we also do not typically use pure passive indexes. Factor-based indices have a convincing record of outperforming their purely passive peers.
We implement our strategies with exchange-traded funds (ETFs), which tend to be more cost and tax-efficient than their mutual fund equivalents.
We implement smart diversification. Constructed properly, a well-diversified portfolio has the potential to both improve returns and lower risk.
We opportunistically rebalance. Rather than blindly rebalancing every quarter, we look every week to surgically sell high and buy low, which has been shown to add to returns.
We systematically seek to tax-loss harvest, reducing client’s tax burden. This is not an end-of-year afterthought, but a year-round search for opportunities.
We aim to keep expenses as low as we can without diminishing returns. The ways we do this range from efficient trade execution to intelligent security selection.
We coach our clients to avoid behavioral pitfalls. While I’m listing this last, research shows this to potentially be the greatest of the marginal gains³. For example, poorly considered market timing can cause irreparable damage to long-term returns.

None of the strategies above are flashy enough to be bragged about at the country club, and no one strategy always works. But together, the consistent application of pressure on the right side of the performance scale has the potential to pay off handsomely in the long-term. Our goal is investor peace of mind. We believe a well-articulated evidence-based strategy, implemented in a straightforward approach, delivering attractive long-term performance, will do just that.

1. Clear, James. Atomic Habits. New York: Avery, 2018.

2. Harrell, Eben “How 1% Performance Improvements Led to Olympic Gold.” Harvard Business Review, October 2015.

3. “Putting a value on your vale: Quantifying Vanguard Advisor’s Alpha.” Vanguard, July 2022.

2.8%

Core PCE Inflation

The Fed’s preferred measure of inflation remained at 2.8% this month as expected.

Headline of the Week

A Little Something For Everyone?

After a week off, inflation news is back on top due to the latest report from the Fed’s preferred measure, the Personal Consumption Expenditure (PCE). The report was largely in line with expectations, with some aspects slightly better and some slightly worse. Early interpretations point to no rate cuts for the near future, but whispers of rate increases continue to fade. The report seems to be a classic example of two steps ahead and one step back. Net, we are one step ahead at getting inflation back to 2%, but it might take longer.

Consistent with something for everyone, markets initially were a bit mixed. Dow and small-cap markets moved higher, while the S&P 500 and tech-focused Nasdaq moved lower. Bond yields moved off of their recent highs.

The Week Ahead

June comes in fast and furious. Central bank rate decisions, a jobs report, and elections elsewhere will all jostle for airtime during the week.

The First to Go

Two big central banks make a rate decision before our turn on the 12th.

The European Central Bank (ECB) is supposed to start cutting rates this week.
While this rate cut has been telegraphed and is widely expected, the debate now shifts to how much more and how soon, making President Lagarde’s press conference a must-see event.
The other major bank on the docket is the Bank of Canada (BoC), which seems to have tamed inflation. If it cuts rates on Wednesday, it may beat the ECB to the podium.
Sharing a border with the United States adds an extra wrinkle for the BoC as they do not want policy rates to deviate too much from their friendly neighbor.

Job Not Done!

The 1st Friday of the month means the non-farm payroll report is coming.

Clear signs are evident that the jobs market is cooling and making the consumer more cautious.
Expectations are that 151,000 jobs were created in May, down from 175,000 in April.
We should get a good picture of the labor market between the ADP report and job openings and labor turnover report (JOLTS) earlier in the week and the Friday jobs report.
The jobs reports should be highly watched releases as the last bits of data ahead of the Federal Reserve meeting.
Also, next week is the Institute of Supply Management’s Purchasing Managers Index (PMI) for both services and manufacturing.

Around the Globe

Elections are happening this weekend for our neighbor to the south and India.

The election in Mexico is billed as the biggest ever for that country.
For the first time, Mexico will have a female leader as the outgoing president Andres Manuel Lopez Obrador (AMLO) ends his term.
The two top contenders are the former Mayor of Mexico City, Claudia Sheinbaum, and Senator Xochitl Galvez, both females.
Sheinbaum is the frontrunner and is expected to continue AMLO’s policies.
In India, the election is advertised as the biggest democratic vote in human history.
Prime Minister Narendra Modi is popular and expected to win a third term by a landslide.
The more important issue with the election is whether Modi and his Bhartiya Janta Party can secure a 400-member supermajority in the parliament.
The Organization of the Petroleum Exporting Countries (OPEC) meets this weekend. It was initially supposed to be virtual, but at the last minute, it changed to in-person in Riyadh, Saudia Arabia.
Expectations are that the cartel will continue the voluntary supply cuts of 2.2 million barrels per day just as the summer driving season kicks into high gear. Crude prices are already up 10% from last year.

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