Buy and Hold: only for Bright People

Googling “fallen fund managers” is a useful exercise for those very many participants in the financial markets who still believe in their own prowess and skill.

Recently the spotlight has been on UK fund manager Neil Woodford but the list of former stars whose light has been snuffed out is an old and very, very long list.

One time hero Anthony Bolton faced a similar fate when late in his career he took up management of the Fidelity China Special Situations.

Bill Miller and his Legg Mason Capital Management Value Trust fund beat the S&P for many years but the grim reaper caught up  with him eventually. After a 55% decline in his fund in the 2008 financial crisis, investors realized that he too (surprise! surprise!) was a mere mortal with feet made of the same clay as the rest of us.

And what of the hedge funds? Oh let us not speak of hedge funds, let us leave those masters of the universe to tell their own tale. How many of those comets have fallen from the sky taking investors’ money with them. Retaining their vast performance fees, naturally.

Take 1,000 young fund managers today and look to see what happens to them in 10, 20 and 30 years’ time. Its called survivor-ship bias. In 30 years time perhaps 5 of them (who knows?) will have become global superstars in international finance. They will have made themselves billions and their investors millions.

But what are your chances of picking those 5 today and sticking with them for the next 30 years.  So that you can pat yourself on the back for your prescience (and theirs)? Fairly minimal I would venture and then by chance and chance alone.

This does not to deny that there are, prescient and hard working people in investment management. It does not imply that fund managers are fraudulent, or negligent or useless. But most of them fool themselves.

What it does mean, what it does imply is that life is a lottery and so is investment. What it does mean is that continued out-performance for long periods of time is most often random chance, not uncanny, supernatural skill.

Why? Why does this happen? Always, and unfailingly? The crash and burn.

Because we live in a universe which is either random and hence unpredictable or deterministic and still unpredictable. How so? Because chaos theory tells us that even if an outcome is predictable (because the rules are finite, bounded and determinable) in practice there are too many variables to take account of and they are intractable and uncomputable now and possibly for ever.

Where then does this leave our humble investor?

How and where should the Man on the Clapham Omnibus (or his US equivalent Mom and Pop on Main Street) invest his savings?

First and foremost he should equip himself with even the smallest modicum of stock market history. And political and economic history. He will find endless cycles each ushering in a new era, a new philosophy, a new political system, economy…and so on. He will find endless companies, governments, countries and civilizations which have disappeared never to rise again.

What he will begin to recognize is that the only permanence is change. What exists today, what works today will not work tomorrow.

Eventually (later, or perhaps sooner) life on this planet will end. And then investment will have no relevance whatsoever.

But in the interim, the investor should ride the wave, he should go with the flow. The wave, the flow can not be defined in terms of single companies. Nor even single economies.

The flow can only be defined in terms of all economic activity on the planet. And that is what the shrewd investor must have a stake in. All economic activity on the planet.

How does that work in practice? Diversification of course. Not narrow stock picking. While economies continue to grow, stocks will grow in value (in aggregate) and will produce an income stream for the investor.

And so will bonds – rising or falling or stagnant interest rates not withstanding.

An index is a “system”. A stock index is an algorithmic method of tracking the winners and discarding the losers. An ETF like MSCI World is really a magnificent piece of algorithmic machinery. It is far from “passive”. Same for a world bond tracker.

If you insist on investing in the latest fads or the latest hot economies you will end up as a loser. On average. Of course some will win through by chance. And by chance alone. Most will end up putting their trust in the latest hot fund manager and eventually they will lose their shirt; or even shirts. But hopefully investors will not have placed their whole bet on red. If he does he will end up investing in Imperial Russia in 1917, Germany or Japan in 1939.

Trouble is of course you have to be bright enough to see the truth and thick skinned enough to ignore the flash boys and masters of the universe who will despise your apparent simplicity.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s