Introduction
Long-term
investment success is much more dependent on people than the elements within a
portfolio. This is my conclusion after studying both investments and investors.
Everyday there are "learning moments" in watching and trying to
understand behavior.
“Goldilocks’ peers”
Last week's blog briefly
mentioned the running of The Preakness and the focus on the first three horses.
I failed to point out the interaction among the first three across the finish
line. While there were other horses in the race, the first three were jockeying
for position with “Goldilocks' peers” for the winner (from the fairytale “Goldilocks
and the Three Bears”). The winner
benefited from this interplay as the two leading horses were expending a great
deal of their energy on dueling each other for the lead in the relatively short
home stretch. The exertion tired them a bit and allowed the well-positioned
horse under an expert jockey in the final steps to rush past the first two that
were tiring. I am guessing that the race would have turned out differently if
either the stretch battle or the positioning of the eventual winner was further
back.
I
apply these observations to competitive investing within assigned investment
objective leagues. Thus, a good investment analyst of performance should
understand each of the likely competitors strengths and tactics. Just focusing
only on one's choice is insufficient. The eventual performance winner says as
much about the peers as about the winner, but far less noted by the pundits.
Recently
my associate Hylton Phillips-Page and I used portfolio structure data on fixed
income from our old firm now known as Lipper Inc. In the fixed income world
there are fewer investment objective leagues than in the equity universe, so
there needs to be deeper analysis. I was interested in understanding why two different
short-term funds were not among the leaders. What we quickly found was the
league that they were being measured in had a wide assortment of different
strategies being used. The maturity and quality constraints on the funds in
question were much more severe than the bulk of the competitors. Thus in the
current bond market the funds that were allowed to take more maturity and
credit risk were producing better near-term results. Thus the owners of these
funds were handicapping their choices. However, this could well be appropriate
as these funds in the owner's constellation of fund holdings were designed to be
reserve elements against a major bond and stock market decline. When we
narrowed our view to funds that were similarly constrained, the tactical skill
and relative expense ratios were more than appropriate. Thus for the owner's
vantage point the key is to examine the constraints applied and not the
specific choice of funds.
Confirmation Biases
(With the exceptions of
the focus on mutual fund performance and the
analysis of five leading securities the following thoughts and quotes are from
a recent article of Farnamstreetblog.)
Often
what passes for considered judgment is actually a summary of our memory. The
problem with that is our memory is selective at what it retains. C.S. Carroll
said "We are what we believe we are." From an investment standpoint,
Warren Buffett's quote is very insightful: "What the human being is best
at doing is interpreting all new information so that prior conclusions remain
intact." (Luckily, according to Charlie Munger, Warren is a learning
machine.) Through the ages there have been similar quotes from Tolstoy, Francis
Bacon and all the way back to the ancient Greeks by Thucydides. As an
appropriate warning to today's investors is the latest advice from Charles
Schwab & Company: "Investors shouldn't get too caught up in the political
wranglings with respect to investment decisions....but remain focused on your
longer term goals." Perhaps the best way to identify the power of our
biases is a poem by Shannon L. Adler which follows;
Read it with sorrow and you will feel hate.
Read it with sorrow and you will feel hate.
Read
it with anger and you will feel vengeful.
Read
it with paranoia and you will confusion.
Read
it with empathy and you will feel compassion.
Read
it with love and you will feel flattery.
Read
it with hope and you will feel positive.
Read
it with humor and you will feel joy.
Read
it without bias and you will feel peace.
Do
not read it at all and you will not feel a thing.
One of
the persistent biases we are subjected to is that Large cap funds under perform
"the market." Those that spout this probably have never read a full
prospectus. Rarely are funds designed to beat a securities index chosen by a
committee to represent the market. From their inception, mutual funds were designed
to convert savings into an investment program to meet eventual funding goals.
These goals included some attention to periodic declines in the market and the
need for daily liquidity and reasonable costs.
What I
find of interest is that I have not seen a single media mention of the
following:
Through
May 25th , 2017, the year to date average of the S&P 500 Index fund is up
8.53%.
Investment
objectives which doubled the 8.53% above to 17.06%, including funds that did
better and worse than average, were as follows:
Global Science
& Tech.
|
+24.73%
|
India
Region
|
23.27
|
Science & Tech
|
20.56
|
Pacific (ex-Japan)
|
20.18
|
China Region
|
18.62
|
Emerging
Market
|
17.16
|
Quite
a number of the much maligned Large-cap funds owned some of the five tech
stocks that produced over half of the S&P 500 gain.
More
interesting to me is that the longer maturity Mixed Asset funds also beat the
market. For example the Target Date 2055 funds averaged +9.65% plus the Mixed
Asset Aggressive Growth allocation was up +9.62%. In addition the average of the
Target Date funds with maturities between 2035 and 2050 beat the market,
Further, the average Emerging Market Local Currency Debt fund was up +8.74%.
I am
not suggesting that a bunch of mutual fund portfolio managers suddenly took
smart pills. What I am suggesting is that the market is dynamic and there are
usually opportunities to wisely invest in funds.
The dominance
of global and domestic Science and Tech has been mentioned above. Also mentioned is confirmation bias. Biases
are short cuts to prolonged thinking and occasionally difficult judgments. I am
concerned that these two streams of thinking may collide soon. As previously
noted five tech companies represented over half of the stock price gains of the
S&P500 so far this year. They are Apple, Alphabet (Google), Microsoft,
Amazon, and Facebook. Note that three of these were prominent in our discussion
last week on Berkshire Hathaway and Sequoia Fund. My concern is that there may well
be confirmation biases at work due to
the use of shortcuts to analytical judgments at work here and particularly by
the media. Four of the five leaders have over half of the revenues from what is
deemed to be a single source. (Facebook 97% from ads, Alphabet 88% ads, Amazon
72% products, and Apple 63% iPhones.) Without any specific knowledge of these
companies, just based on my historical memory as an electronics analyst, all of
these will eventually see a decline in some of their revenues from these
identified sources. When and if this happens perhaps their stock prices will
decline. From my viewpoint this could be a good buy point as all five of these
companies appear to have promising developments underway. One may have to be
patient due to the short cutters’ disappointment which follows a quote from Robertson Davies
"The eyes sees only what the mind is prepared to comprehend."
__________
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A. Michael Lipper, CFA
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