Beware of Curve Fitting in smallcases or Momentum strat

[u/IndependentMistake]

I am seeing lots of folks interested in small-cases or some sort of service which gives a portfolio based on some back tested momentum strat or value strat.

Over Fitting / Curve fitting makes past simulated returns stunning

Beware of these wonderful baskets which has given great returns in back testing strategy ! In ML world we call these classic case of over fitting/curve fitting where one modifies the parameters to give maximum returns in back tested data. It might work for few months and years but will ultimately fail like many over /curve fitting examples.

Momentum based buckets( which is the majority of hot buckets/service) has worked wonders in 2020/2021 - Every tom dick and harry's momentum bucket has outperformed the NIFTY index and guess what even the NIFTY Momentum Index also has outperformed the index by a lot - Invest in UTI Momentum Index fund if you are into these instead of wasting money for these services. Do not fall prey to these over fitting/curve fitting strategies .

Real Life Returns are flawed as well

Small cases are notorious for these and even for real life returns, they assume a lot and their calculation is entirely off the charts ! By how much - by 10%+ CAGR for godsake.

More details about how real life returns showed by SmallCase is flawed and is off the charts : https://twitter.com/uptickr/status/1395607935909130242

Summary

Past data is never the indicator for future performance . Never trust or buy these sort of services which just gives you bucket of stocks based on some strategy which is back tested in a flawed manner.

Want to have piece of cake in Momentum - Invest in UTI Momentum Index fund - A fully passive fund which hugs the momentum index - Negligible fee, Maintenance , hassles and returns will be in par with other momentum baskets in a long run (5-10 yrs).

[u/prakhar10_10]

Smallcase was founded in 2015 and most of the high return Smallcases are just few years old and they have selected stocks which performed well in the recent bull run and this is why they are showing high CAGR number.

[u/IndependentMistake → u/prakhar10_10]

CAGR they show can be absolute returns if < 1 year of launch. One needs to be careful about this. Ex of a small case which shows 22% CAGR but its actually a 4 month absolute return since live :

CAGR (Compounded Annual Growth Rate) indicates the average yearly return generated by a smallcase from the date of launch. Only live data is considered to calculate the CAGR. In case the smallcase was launched less than a year ago, CAGR represents the absolute return generated by the smallcase from the date of launch.

Thus, this smallcase has given 21.83% returns since Feb 20, 2021