We live in an age of information overload, and while education en masse has its benefits, it can sometimes be a double-edged sword.
The financial media and security analysis landscape has expanded to accommodate new forms of information collection, examination and dissemination to an audience larger than anyone once thought possible. Gone are the days when stock quotes and earnings reports had to be requested or read statically in a daily newspaper. With the invention of the internet and the proliferation of web-based research companies updating statistics in real time, your average Joe can look up Apple’s financial statements dating back to its 1980 IPO with a quick search on the SEC’s website.
New tools like online brokerage accounts and social media have brought more investors into the market and provided the masses access to more sophisticated information and analysis than ever before. This information overload is compounded by the thousands of equity analysts on Wall Street with the sole job of diving deep into financial statements and making stock recommendations to the investing public.
But given how easy it is to access data and analysis today, relying solely on publicly available information—or those that can be found on a company’s balance sheet—is no longer enough to gain a competitive advantage in the market. Traditionally, it was generally accepted that there were pockets of opportunity in smaller companies or industries that attracted less attention than the blue chip stocks. Because of the lesser amount of widely disseminated publicly available information surrounding these companies, as well as a smaller pool of equity analysts paying attention to them, it was generally thought that one could discover an informational advantage by delving into their financial statements.
For example, there are hundreds of equity analysts and reporters covering Apple. The chances that one of them missed an important nugget of information in the company’s most recent earnings report that could be harnessed as an informational advantage is highly unlikely. But historically, it was possible to find informational advantages within the income statements of smaller companies, like insurance company CNO Financial Group for example, which only has a handful of analysts covering it.
Perhaps some investors are satisfied with subpar or on-average returns because they’re slicing and dicing the same information as everyone else. But I’d take a gander that most investors want to outperform the broad markets and utilize managers that have a unique “secret sauce” influencing their decisions.
However, in an era where everyone is making decisions based on the same information, how can an investor or financial advisor generate alpha when there’s a herd of other investors acting on the same information?
In this environment, investors need to find something else that can’t be found on a company’s balance sheet or heard during a quarterly investing call. The traditional, known factors have been poured over and are already baked into the stock price of every publicly traded company. Investors and financial advisors solely relying on traditional financial metrics to base investment decisions are probably going to have a very difficult time outperforming the market with regularity. To consistently generate alpha, investors must look beyond publicly available information if they wish to secure a repeatable, informational advantage. But what could this be?
The answer lies in off-balance sheet data that can be collected and analyzed to glean forward-looking information that isn’t readily apparent to the masses today.
The smart beta revolution is indicative of this strategy. Investors realize that if they only utilize one, over utilized factor to make decisions—such as market-cap weighting—nothing will differentiate their portfolios from one another.