If markets don’t develop as expected over a longer period of time, many investors are often too quick to throw their principles overboard, Stefano Lecchini, Portfolio Manager at LGT, writes.

By Stefano Lecchini, Portfolio Manager at LGT

Financial markets are highly dynamic, volatile and complex systems. They are well-studied, which means that investors have an extensive arsenal of analysis and calculation methods at their disposal for assessing risks and future trends.

They have the best prerequisites, really, to make well-founded and successful decisions using established and reliable methods. In practice, however, the opposite usually proves true: investors are often forced to question the validity of the principles they have established for themselves.

A Long-term Perspective, But Short-winded

The historical development of a specific investment strategy is an important instrument for analyzing its quality and to strengthen confidence in a strategy. The longer the strategy’s track record, the better: a long-term perspective also allows for difficult periods to be recognized and then potentially relativized by the good periods that follow. That is, at least, the theory.

In practice, investors seem to lose patience quickly: when a difficult period sets in that is perhaps a bit longer than in historical comparison, confidence in the strategy is quick to dissipate. At that moment, the longstanding history appears to be less relevant and investors’ investment horizons shorten dramatically: they rarely ride out the difficult period and instead, opt to exit quickly – despite all of the findings garnered during the initial assessment phase.

The Transitory Nature of Established Findings

If, in the vacuum of logic, investors consider which fundamental characteristics an investment should have, they will probably include the following on the list:

  • 1. attractive potential for returns
  • 2. liquidity
  • 3. transparency
  • 4. diversification
  • 5. limited volatility

In the context of this thought experiment, every investor would recognize that in practice, no investment can have all of these characteristics at the same time. An investment in managed futures strategies, for example, features the first four fundamental characteristics, but one of its attributes is a higher level of volatility.

In theory, this combination is something that everyone will endorse – but what do most managed futures investors complain about? The volatility of their investments. The initial logic behind such an investment thus appears to quickly be forgotten.

The Hidden Illusion of Investing

Are systematic investment strategies better than active management? An investor conducting a thought experiment in a protected and loss-free environment would come to the conclusion that both approaches have their own advantages.

Notwithstanding, the opposite can currently be observed in the financial sector: after difficult years for active investors, systematic investment strategies are on the rise, as if the dream of a money-making machine were no longer an illusion.

«Voyage to Make Money»

But believing that an algorithm has found the solution for generating and multiplying money is absurd. Investors take a number of principles along with them when they embark on the «voyage to make money», which are supposed to steer them as they navigate and give them security. If, however, one no longer recognizes the stars in the sky, the wind comes from an unexpected direction or the storm seems to have no end, disorientation quickly sets in.

The investor’s own principles for navigation are quickly thrown overboard and replaced with new principles. Only the most experienced of investors stays the course even in choppy seas, while many others go astray or suffer a shipwreck.

Stefano Lecchini is a Portfolio Manager at LGT and develops hedge fund solutions for institutional clients. He completed a Master’s in Theoretical Physics at ETH Zurich and a Master’s in Philosophy at the university of Bern. Following his studies, Stefano Lecchini, who is a fan of literature and soccer, gained initial professional experience in the consulting and investment banking industries.