Last year was a stellar year for investors – in 2023, the Nasdaq 100 rose 54% for its best annual return since 1999, while the S&P 500 gained 24%. The Magnificent 7 were the de facto leaders of this market rally, with the group’s returns averaging 111% for 2023 and accounting for more than 60% of the S&P 500’s annual gain.
This was the opposite of 2022, the only year in history in which Treasury bonds and the S&P 500 both lost 10%. It was a year so rough that it marked the greatest destruction of wealth in modern history with an estimated $57.8 trillion lost across all asset classes combined.
And while 2023’s Big Tech-driven rally looks superb in headlines, a deeper glance shows this was not always the case – especially when accounting for 2022’s steep losses. In fact, on a 3-year cumulative basis, the indexes’ performances make a strong case for investing in indexes over ETFs.
Simply put, allocating only to a leading sector, such as cloud in 2020 and 2021, would lead to significant underperformance through 2022 and 2023, when multiples were cut dramatically as budgets were slashed. Semiconductors underperformed in mid to late 2022, but outperformed significantly in mid to late 2023. It’s these disparities in between different sectors of tech that prove the value of active investing versus passive investing.
Our firm believes that having an actively managed portfolio is where you get the best of both world’s – performance that far exceeds the indexes and ETFs by paying close attention to allocation, (quickly) cutting stocks that do not meet specific criteria, and choosing stocks that have strong, fundamental strength.
The I/O Fund is releasing our official 2023 returns plus our updated cumulative returns next week --- so stay tuned to your inbox. Our returns help to prove an actively managed portfolio can exceed all indexes and major ETFs on a cumulative basis (that we are aware of).
However, before we release our returns, we think it’s prudent to discuss the importance of verified returns for retail investors. The I/O Fund goes to great lengths to deliver a rare level of transparency for our Members. This is not about a victory lap; it’s about raising the bar. We do not know of another research site that publishes every single trade in real-time, and then takes this further to have their performance independently verified. We do this because it’s the right thing to do, but there are other reasons putting our best foot forward with verified returns is important for retail investors.
The New Norm of Quant Trading Puts Retail at a Disadvantage
Algorithms account for up to three-quarters of equity trading volume, as hedge funds and investment banks are increasingly turning to algorithms and quant trading systems to outperform benchmarks. Algorithmic trading is one of the primary culprits to the extreme volatility seen in recent years, most notably with the flash crashes and rallies of 2020.
This creates a serious disadvantage for retail investors and those who do not have a team of Python developers to leverage quant systems that trade in the blink of an eye. Ray Dalio, the fund manager for Bridgestone, has openly discussed that the best approach to the modern-day stock market is what he calls “the man and machine.” His firm has 1,500-employees that use computer models to test hypotheses; which is just one of the many advantages hedge funds and institutions have over retailers.
According to Dalio, the ideal is to have an algorithm work alongside a portfolio manager for a customized approach to predicting the markets. Although the I/O Fund does not have a team of Python developers, we partnered with Vincent Duchaine of WealthUmbrella in 2022 to close the gap between human-driven actions and emotionless machines.
This marked an important turnaround for our firm as we gave up what I would call “retail idealism” which centers around the idea that holding a stock for a long period of time is retail’s only defense. This works during times of economic expansion, but where this can go (horribly) wrong is when a new, more challenging macro changes the outlook for any given company.
For example, in 2022, hundreds of tech stocks finished down 70%, and nearly every tech stock finished down 50%. This includes the indestructible FAANGs, with many falling to trade at historic low valuations. An investor would have to be in denial to focus on the poor performance of an individual company rather than acknowledge something much bigger was going on. 2022 highlighted a crucial yet overlooked point (that we encourage our readers to do): let go of the idea that picking good stocks alone can save a portfolio in the tech industry and to instead fully embrace risk management tools.
2023 reiterated this point very well – although numerous stocks saw face-ripping rallies, such as Nvidia’s 239% rally and Meta’s 156% gain, only a handful outperformed and ended with positive returns on a 2-year basis from 2022 through 2023. Looking at Meta, despite that 156% rally, it ended just 5.2% higher since the start of 2022. Tesla rallied nearly 102% in 2023, but since the start of 2022, returns were (-29.5%). Alphabet’s 2-year return was (-2.6%), even with its 59% rally in 2023.
Risk Management Tools
In April 2022, the I/O Fund stopped relying on stock picks as the primary, offensive measure because this approach simply wasn’t working with the new macro. After partnering with Wealth Umbrella on an automated hedge, the I/O Fund began to boldly hedge up to 100% of our portfolio, at times, and we still continue this approach today.
We pivoted to playing defense rather than offense. Those who watch team sports will understand this transition well, as the strategy changes from attempting to make money (or make a goal) to a strategy that prevents losses (or prevents a goal).
Unlike many other all-tech portfolios and ETFs, we believe a more active stance is necessary for long-term tech investing. We also believe that the easy years of buy and hold are over, marked by the narrow leadership we saw in 2023 where a small number of stocks drove the rally last year. As a result, we rotate our portfolio frequently, raise cash and actively hedge our portfolio with an automated signal.
Real-time trade alerts are sent to our members the minute we decide to buy, sell, trim or add to a stock. For those who may not be aware, this is extremely challengingextremely challenging to do as it combines the two most advanced forms of portfolio management.
