Wall Street Transcript Interview with the Chief Executive Officer of Empirical Wealth Management: An Evidence-Based Approach to Addressing Risk and Return in the Markets

Wall Street Transcript

67 WALL STREET, New York - October 29, 2012 - The Wall Street Transcript has just published its Investing Strategies Report offering a timely review of the market for serious investors and industry executives. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Socially Responsible Investing - Value Investing - Small-Cap Investing - Evidence-Based Investing - Risk Management - Downside Protection

Companies include: S&P 500 (SPX) and many others.

In the following excerpt from the Investing Strategies Report, an expert money manager discusses his investment philosophy:

TWST: The firm's investment philosophy centers on evidence-based investing. Would you please explain that more for us?

Mr. Smith: Sure, the ideal of an evidence-based approach to investing is actually borrowed from the concept of evidence-based medicine. In that case, a common definition is "the conscientious, explicit and judicious use of current, best evidence in making decisions about the care of the individual patient. Integrating individual clinical expertise with the best, available external clinical evidence from systematic research." In our case, the patients are the individual investors that we serve acting as their personal financial advocate. It is our job as their adviser to connect our expertise and the latest, independent research to their unique financial objectives and personal characteristics.

Being an evidence-based adviser means that you won't engage in strategies when the most current and widely accepted evidence leads you to believe that the strategy is not in the best interest of the client. You will use strategies that are grounded in evidence to build customized solutions that meet your client's financial objectives and their personal preferences without compromising your fiduciary responsibility to place their interests first. This commitment to the evidence means that, at times, you will not be able to satisfy every potential client, and often you will lose opportunities to advisers offering approaches that promise something where no evidence exists that they can deliver what they are promising.

Let's take an extreme. Assume a client comes to us and states that they have an objective to beat the S&P 500 index by 5% per year over the next 20 years by focusing on a subset of our favorite 40 stocks out of that index. Rather than happily taking the clients money and agreeing to build the strategy, we would discuss the evidence showing the likelihood that any adviser would be successful in that endeavor. Evidence suggests it is very unlikely. Further, we would engage that client to determine what return they really need to meet their objectives over a specific period of time. Then we would reset expectations given what evidence shows us is reasonable to expect from portfolios of various risk levels that match with the investor's situation.

The investment industry has not had a great track record of using an evidence-based approach to offering investment and wealth-management solutions. Instead, the industry has put more focus on creating products and solutions that solve yesterday's problems or offer a path to get rich quick, all the while ignoring the evidence suggesting that most of these strategies are not productive to the individual investor. We hope to change this.

Currently, the investment funds we utilize are generally more passive in nature, and the reason is because the preponderance of evidence shows that actively selecting a handful of stocks in hope of beating the S&P 500 will not work. In fact, that traditional "beat the market" approach exposes clients to the peculiar risk of not meeting their objectives even during periods of positive market growth through the underperformance of the approach. It doesn't mean people don't try it, because they certainly do. Much of the investment industry is based around trying to beat various parts of the stock market. But in our view, there is overwhelming evidence against it, so we are not going to engage in trying to beat the index through traditional means.

We just wrote a paper about capital market expectations. You can find it on our Web site. In that paper, we discuss how many market predictions are made and are wrong. Many of the predictions we see are people making very short-term and often radical predictions for the stock market. However, there is very little evidence demonstrating that anyone can do it over short periods of time - daily, weekly, monthly. The only evidence we find for developing expected market returns is over very long periods, say 10 years or more. Over longer time periods, the range of experienced returns becomes narrower, and it's much easier to make a forecast that will be reasonably accurate, although it won't be near perfectly accurate. We make our decisions based on true evidence, not based on conjectures or guesses.

TWST: Do you look at quantitative or qualitative evidence?

For more of this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

View Comments (0)