Do you ask questions of “How are Your Flows?” and “What’s Your Economic View?” or
“What is Your Edge?”and “Why will it persist?”
There is a good reason for the disclaimer that “past performance is not a reliable indicator of future performance”. Performance is based on a single sequence of events that actually occurs. No one can measure a portfolio in advance. We can’t consider a probability weighted sum of infinite possible scenarios. Worse still, risk analysts use realized historic outcomes to model possible future ones behind a facade of scientific rigour.
A successful process is to buy cheap stocks and sell expensive ones. We suffer from an “illusion of skill”. Despite luck’s important role we celebrate the “Fund Manager of the Year” and hold single stock-picking jamborees. The low correlation between yearly performance tables renders this futile. Fund Managers of the Year often privately curse awards as peaks in their business. The lucky get luckier, attract capital, grow their businesses and become more visible. Their opinions seem most valid often just as their luck runs out, and “mean reversion” starts to kick in. No wonder experts’ predictions have been proven worthless on average. Self-attribution bias. Humans tend to take credit for good outcomes while blaming bad luck for poor ones. Australia avoided the GFC because of Chinese resource demand, not the quality of our leaders; though they may have you believe this! Stock analysts also exhibit this bias, perhaps you do with funds. Best managers are not always the best short term performers. Portfolio Construction at its heart accepts different assets, funds, or stocks do well at different times. Staying the course is the challenge.
“Tools of selling” are at odds with “tools of investing”. Every salesperson knows “How to win friends and influence people” –the 1930s book remains a bestseller: Listen, Take an interest, smile, use peoples’ names. Above all, avoid disagreement, conflict, arguments. However, most successful fund managers have a contrarian bent, they take the market on … ... unless a fund manager takes on the market they accept the market is right and If they accept the market is right, an ETF will replace them! Successful investing is often about challenging consensus thinking.
Fund managers exploits Personification, Slogans, Familiarity and Story-Telling. Personification is epitomized by profiling and celebrating Star Fund Managers. Meanwhile evidence suggests funds with multiple portfolio managers generate better results. The importance of organisations over individuals is confirmed in work by Boris Groysberg on Stockbrokers, Klaas Baks on Mutual Funds, and Ben Darwin on sporting teams. Most ambitious start-up managers learn this once beginners luck wears off but genuine investment houses far outlive their founders. Slogans cut corners and are led by whatever’s hot at the time. Today, the word disruption feels overused, yet it’s been happening since the Industrial Revolution. We hear back, unchallenged, agreeable wisdom that sounds convenient. Familiarity is another problem. In our sphere of global investing, many used to ignore overseas stocks, using exporters as their ticket to the world. Buy Nestle because everyone drinks coffee, buy Apple because everyone has an iphone or buy Colgate because everyone cleans their teeth. This ignores price, the key driver of returns. Well-known companies are often fully-priced. Storytelling has passed wisdom down through generations. However, well-crafted, carefully selected, engaging stock stories delivered by strong and entertaining presenters will often have already performed. Charlie Munger noted it’s hard to separate true knowledge from a learnt show full of eloquent words, phrases and ideas. Jargon is often used to sound authoritative. Ambiguous answers are commonplace but “markets could go up or down from here” is as valuable as a horoscope. Our love of stories exposes us to “Fundamental attribution error”. We allocate reasons for events to explainable packages.
“What’s your economic view?” a superior portfolio not priced as such will do well over time. That’s the goal. It’s ironic. The best investment decisions are the most uncomfortable. Unless timing’s perfect, they fall before they go up. Active managers relies on a rare talent for exploiting uncertainty, disagreement and complexity. Finding a rare and genuine edge in delivering long term performance for clients is the goal of fund selection.
To do this you must embrace complexity and diverse views, avoid celebrating individuals over teams, and deepen the focus on understanding the viability and sustainability of organisations and their processes.
The 2 “tools of selling” are at odds with the “tools of investing”. And if fund managers focus on these over performance, disruption is inevitable.
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