By Julian Koski, CIO and co-founder of New Age Alpha

If one thing in life is true it’s what you don’t know WILL hurt you. Just ask that rube who lost $ 20 playing Three-card Monte… or that fly that got tricked into landing in a Venus Fly Trap. Everywhere, pitfalls lie in wait for the uninformed and this is no less true in the world of investment. The danger that harms people the most, however, concerns the exact amount of information they know. Because the difference between what we know and what we think they know is vast and false assumptions are often worse than outright ignorance.

False head and false points

One of the best examples of false assumptions happened on a Sunday afternoon on the football field. In a close race to lead the AFC East, the Jets led 24-21 over the Dolphins with 38 seconds left. Miami quarterback Dan Marino provided a pass that took them to the seven-yard line and fellow Dolphins rushed to the line of scrimmage to prepare to kick the ball – a tactic in the football where the QB deliberately throws the ball to the ground. Although it counts as an incompletion, it also stops the clock. This means that it is also an improvised time-out and is a common practice at the end of close matches.

Except that Marino did not really tape the ball. With a nod to his receiver, Mark Ingram, he and the Dolphins acted like they were going to blow him up… screaming and spinning as if to gain precious seconds. Meanwhile, the Jets were lazing down to the line of scrimmage, showing no urgency. Everything the Jets had been conditioned to expect in the football world told them the Dolphins were spiking the ball. In the words of announcer, Paul Maguire, referring to the Jets, “They stopped… they all stopped!” And Marino shot a barely covered Ingram in the end zone to win the game.

What impact does this have on your investment portfolio? The insidious power of false assumptions. It’s relatively easy for a person to admit that they don’t know something. Much more dangerous is the assumption that we know something when they really don’t know it. The Jets assumed they knew what Marino would do next. They were wrong. And they lost.

“Beware of false knowledge; it is more dangerous than ignorance. – George Bernard Shaw

In the investment world, some analysts have tried to objectively measure these false assumptions via the Citi Economic Surprise (CESI) indices. These are indices designed to measure whether or not the economic data of a given country is exceeding expectations. Many times, commentators have used the index to gauge the strength of an economy and, in fact, some have used a negative reading to imply that the economy may be heading into recession. But this is another example of a false assumption that is more dangerous than outright ignorance.

The tricky part here is the denominator in the metric. CESI tracks economic data relative to expectations – up when the data exceeds economists’ consensus estimates and down when it doesn’t. But what if these economists are simply wrong? Investors can read how Citi’s economic surprise indices turned negative and decide that it is a reflection of the economy as a whole when in reality, it is simply a reflection of the economy. people’s expectations. It’s a huge difference. In fact, indices were built more for FX trading than to serve as a reading of the overall market. Citibank, the creator of the index, readily admits it. But — human behavior being what it is — that hasn’t stopped prognosticators from forming opinions based on this false assumption.

Keep your head in the game

At New Age Alpha, our primary investment goal is to avoid human behavior. This includes avoiding false assumptions and any other bias that could lead to a mispricing of securities. We believe that humans, by their very nature, misinterpret vague and ambiguous information and feed it into the course of action in a consistently incorrect manner. To mitigate this risk, we have applied an actuarial approach to asset management and developed a proprietary metric to help calculate the likelihood of a company being overvalued or undervalued. This is called the human factor and it calculates this probability solely on the basis of the company’s stock price and known financial information. We don’t rely on false assumptions like the Jets did, nor on metrics that misjudge opinions. We are only trying to answer the question: what is the probability that the company will fail to generate the growth implied by its share price?

The results? We believe we have created a new source of alpha by building a portfolio of stocks that differ from the main names of the main indices. By avoiding losers, rather than trying to pick winners, our US Leading 50 Index beat its benchmark, the S&P 500 TR Index, without resorting to the often time constraints of a sector or factor. Below, we compare the performance of our index to the ten largest US large-cap ETFs by asset under management as defined by the Morningstar category as of 08/31/21:

Source: Morningstar Direct, New Age Alpha

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.