Sunday, September 22, 2013

Investor Mindsets Mine Different Results


Is changing investment attitude all that is needed to change investment results? Is it as simple as flipping the coin to the other side? In my search for these and other problems I often take the contrary view or flip the coin to the other side. I do this frequently in my conversations with CEOs of investment firms, chief investment officers, portfolio managers, analysts and most importantly investors. I try to learn from all of them to help the accounts for which I am responsible.

Lessons from Budapest

My wife Ruth and I have just returned from a much too short visit to Budapest. We were part of a small group of senior and/or retired leaders of stock exchanges from around the world. On the last evening of the conference we separated ourselves from the group to meet to meet for dinner with nine locally based CFAs.

When we sat down around a large round table, I thought the analysts took random seats. However as the evening evolved what became clear was that those seated on the left favored intervention by “authorities” and those on the right were very much for markets to develop freely. This right vs. left discussion has caused me to think about a two-sided model of thinking in which the wise investor and his/her manager can periodically flip the coin over.

The two-sided model

The interventionists were blaming the market and the economy for misallocation of resources to the effect that the middle class was being squeezed. Their solution was to raise taxes on the wealthy and fund the government’s redistribution efforts. The free market types thought that restrictions on corporate activities should be lessened so that businesses could hire more through their expanded profits. (I suggested that the quickest way to accomplish this was to reduce or eliminate the taxes on dividends.) From my point of view, this discussion could be boiled down to a simple equation. The external “they” need to take command vs. “we” need to be freer to produce for all to benefit.

The juxtaposition of the dinner with the conference did create an interesting insight. The blamers were incensed about High Frequency Trading (HFT). Based on the discussion at the conference I indicated that there is little evidence that the individual investor is materially harmed by HFT. Further it was pointed out that due to its loss of profitability, one of the largest independent HFT shops has had to acquire another firm whose basic business was executing orders for correspondent firms. (In other words, market forces have reduced the attractiveness of HFT to the point that it is no longer attractive.)

The other dichotomy that hit me in retrospect is that blamers saw the markets and their economy to be hemmed in by walls. (Remember the dinner was held in Hungary.) I guess it is my training from the US Marine Corps: where others may see a wall I see a hurdle to either get over or around.

Other two-sided models

To me the single most important determinant for investment policy is what time horizon will be used to judge success. Because of the frequency of publications, the media is interested in things that change rapidly. Note how much more coverage there is for short or sprint races than the longer cross-country events. The money that we are responsible for needs long-term success. Our clients want success for ten years or longer including multiple generations. I urge you not to fall into the trap of using three year data which can show performance going in a single direction and not the more characteristic up and down patterns of history.

Turnover rates

Allied with the need to set time horizons for accounts or even parts of an account, is the speed of required decision-making. Trading accounts could turn over their portfolios 100% every single month adding their managers' trading skills to the results earned in the underlying asset class. In contrast, successful equity managers investing for the longer-term have a complete turnover of their portfolios only every four to five years. Turnover, in my opinion, is not a cause of good or poor performance, but is a symptom of the speed of decision making and the time horizon focus.

Risk assumption

Many investors wish to avoid taking risks. (Risk is a loss that is so large as to put the long-term goal of the account in jeopardy. Risk is not volatility which may be uncomfortable, but does not threaten the accomplishment of the mission unless the discomfort forces the investor to jump out before the long-term time horizon is reached.) On the other side of the coin there are those that are risk seekers or at least risk tolerant as long as the risk is appropriately priced and diversified. The first group, (the risk avoiders) will occasionally be surprised to learn that ‘riskless’ is an incomplete title. Further, they may be out of position for recoveries and further expansionsBeing out of the market for as little as ten days can lead to poor multi year results.


Oscar Wilde said that a cynic knows the price of everything and the value of nothing. He could have applied that to those that can and do tell investors everything that is wrong with any investment under review. The cynic and the blamer have much in common. Both can have a great deal of facts to buttress their arguments, but both presume that they know all that there is to know. The believer understands bad things can and will happen but that there are some good things that will also happen. The long history of the human race is that the believers are more often correct than the blamers.

What to do now?

I can not predict the future, but falling back to my experience handicapping races I can identify both probabilities and possibilities. At the moment the short-term signals from the bond market in terms of driving the equity market turned favorable, with the Barron’s Confidence Index dropping 1.7 points to 74.2. Normally the weekly move is 1 point or less. As this is a contrary indicator when it declines it is projecting a good stock market. However, twelve months ago the indicator had a reading of 66.3 which did lead to a remarkable bull market over the last year (more than twice a perceived normal rate of improvement). Considering the remarkable rise we have enjoyed since the first quarter of 2009, I would not be committing sizeable new money into the markets just yet. Nevertheless, I have a positive long-term view and am willing to assume well-priced risk in the global market.

Where are you in your thinking?
Please let me know.
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