Over the last 5 years the annualized return of Morningstar’s “Small Value” category is 5.0%. O’Shaughnessy Asset Management’s Small Cap Value Fund’s performance isn’t 5 years old yet, but it has lagged the “Small Value” category by a compounded average of 61 basis points per year over the last three years, so I suspect that if it had been 5 years old, it would have done worse than 5%. I have read a lot about this fund, and it is not over-optimized based on backtests. It is a very well-run and well-designed fund that uses many of the same principles that Portfolio123 has always espoused.
I think we should all accept that the S&P 500 has outperformed everything in sight and that the markets over the last few years have been extremely kind to investors. Considering that capital inflows into public markets have been high recently while inflation has been low, it has been very hard for small-cap value-based strategies (and that’s what most of the designer models are) to outperform a large-cap index.
I also think that if one were to create a strategy that WOULD have outperformed SPY in the last five years, it would have no better chance of excellent out-of-sample returns than a strategy created by the same methods five years ago, which would have likely failed to beat SPY in the last five years. There is no single method to create a strategy with excellent out-of-sample returns. For example, people have been using machine learning to try to game the stock market for just as long as people have been using Portfolio123, and it certainly has potential, as RenTech’s Medallion Fund showed. But that fund held stocks for a day or two and used massive leverage (if you were to deleverage their results and not include their fee-based income, their performance may not have been so impressive, though that’s just a wild guess on my part).
The designer models placed a lot of faith in automation. I know stock pickers who don’t automate their strategy at all who have done very well over the last five years. Does that mean that automation is worse than manual stock picking? Absolutely not. They are two different approaches out of many, and that many includes machine learning and long-short hedging and market timing. In the end, what works? Hard work, experience, constant learning, and sticking to your guns when things go bad. And what else works? Large-cap index funds. At least for now.