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WHY EXPECTATIONS INVESTING WORKS

Institutional investors consistently underperform passive funds that track market indexes like the S&P 500 for four primary reasons: the tools they use, the costs they incur and fees they charge , their incentives, and style limitations. The expectations investing approach resolves these constraints, enabling investors to achieve superior returns. The chart below summarizes the critical differences between the standard investment approach and expectations investing: 

 

 

TOOLS

COSTS

INCENTIVES

STYLE LIMITATIONS

Standard Practice

relies on accounting-based tools like short-term earnings and price-earnings multiples, which don’t reliably capture expectations

annual operating and management investment expenses average about 2.5% a year, meaning investors earn only 75% of an annual long-term return of 10% (excluding taxes)

since fund shareholders generally compare their quarterly returns to a benchmark like the S&P 500, fund managers obsess over short-term relative re-turns rather than focusing on identifying mispriced stocks

most professional money managers pigeonhole their investing style as either “growth” or “value”—thus limiting their universe of acceptable stocks

Expectations Investing Approach

pinpoints market expectations, then taps appropriate competitive strategy frameworks to help investors anticipate revisions in expectations

establishes demanding standards for buying and selling stocks, resulting in lower stock portfolio turnover, reduced transaction costs, and lower taxes

improves the probability of beating the benchmark over longer periods, provided that the fund manager can buck the system and embrace more effective analytical tools

doesn’t distinguish between growth and value, but instead pursues maximum long-term returns within a specified investment policy; helps identify both undervalued stocks to buy or hold as well as overvalued stocks to avoid or sell in the investor’s target universe

(Source: Expectations Investing by Alfred Rappaport and Michael J. Mauboussin; Harvard Business School Press; October, 2001)

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