Josh Brown has an interesting piece up this morning in which he outlines the dramatic shift within the investment industry from commission-based (suitability standard) selling to fee-based (fiduciary standard) management and uses that data as an explanation for the tremendous underlying bid seen in the equity markets of late. “It’s amazing that almost no one has connected these dots before.”
It’s not that I entirely disagree with Josh here (and we don’t disagree often). He is on to something noteworthy. But it’s a story I’ve heard before. Those dots have been connected, with a less-than-stellar outcome. Continue reading
With a new report out from the Yale Endowment, now is a good time to do a heat check on how the so-called “Yale Model” of investing is doing. I have written about the Yale Model numerous times (see here, here, here and here, for example). It emphasizes broad and deep diversification and seeks to exploit the risk premiums offered by equity-oriented and illiquid investments to investors with an investment horizon that’s sufficiently long – in Yale’s case, essentially forever. It has worked exceptionally well for Yale. For others…not so much. Continue reading
Investment Belief #4: Randomness must be actively accounted for as part of the investing equation
For at least the course of my lifetime, we Americans – all of whom are said to be “created equal” – have held to a straightforward construct of the American Dream, where it’s always morning in America. In its telling, we are a people of unlimited power, promise and potential. The keys to our success are not status, wealth or connections, but rather ability, ambition, and drive. Anybody can become whatever he or she wants. Life is thus a ladder, there to be climbed by anybody willing to step up.
James Truslow Adams coined this evocative phrase in his 1931 book, The Epic of America. His American Dream is “that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is…a dream…in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”
Over the last few decades, a darker vision has grown up. Many of those who claim to have “done their part” by going to school, gaining new skills or working hard do not perceive themselves to have received reward commensurate with their efforts and abilities, leading to great disappointment and some remarkable income inequality. Indeed, since at least the dawning of the 21st Century, this Dream has turned more nightmarish and been deemed outside the reach of many. Investments haven’t seemed to live up to their earlier promise either, with two major financial crises since 2000 terrifying an entire generation of potential investors. It’s as if (in the words of the critic Andy Greenwald), by some cruel trick, we have come to realize too late that someone or something has tipped the ladder of success sideways, the rungs casting shadows tall as prison bars.
As a consequence, political activists of all stripes actively point blame and propose solutions. But on a personal level, we are all prone to self-serving bias – our tendency to attribute our successes to or own effort and skill but to attribute less desirable outcomes to bad luck. In point of fact, and irrespective of the political conclusions one draws from the current state of the American Dream, luck (and, if you have a spiritual bent, grace) plays an enormous role in our lives – both good and bad – just as luck plays an enormous role in many specific endeavors, from investing to poker to coin-flipping to winning a Nobel Prize. We don’t like to think that much of what happens (and happens to us) is the result of luck – i.e., randomness. We hate the idea of so much that is so important being outside of our control. But how we feel about a given proposition tells us precisely nothing about whether or not it is true and there is no disputing the facts. The random is an important factor in our lives, and, despite how counterintuitive and contradictory it may sound, we need to plan accordingly. Continue reading
Every year Barron’s reports on the Penta asset-allocation survey of 40 leading wealth management firms (such as Barclays, Fidelity, Goldman Sachs, JPMorgan, LPL, Morgan Stanley, Northern Trust and the like), which outlines in broad terms what those firms’ base recommended portfolios look like. The new survey is noteworthy in that overall allocations to stocks rose to an average of 51.1 percent, up from 48 percent at this time last year and 45 percent in early 2012; fixed-income holdings continued a two-year decline, now at an average 25.8 percent, down from 29 percent last year and 34 percent in 2012; and recommended hedge fund and private-equity allocations, recently “the expensive disappointments of the portfolio” and subject to widespread criticism, are up to an average of 14.1 percent from 12.5 percent last year, with all alternatives (including real estate and commodities) now weighing in at an average allocation of 20.4 percent. A more detailed breakdown is charted below.
Earlier this week I wrote about the growth of the sports analytics movement, particularly in baseball, as an inevitable outgrowth of trying to make one’s beliefs data-driven and thus reality-based. “Arguments and beliefs that are not reality-based are bound to fail, and to fail sooner rather than later.” I also noted that the investment world needs similar growth and development.
But despite the exponential growth in the use of analytics (earlier this year the Phillies became the last Major League Baseball team to hire a full-blown stats guy), not everyone in baseball (as with investing) has gotten the message. For example, The Book goes into great detail about the percentages and when it makes sense to execute a sacrifice bunt and finds — conclusively — that sacrifice bunts are grossly overused and rarely make sense. Simply going back over previous games so as (a) to calculate how many runs each team scored when it had a runner on first and nobody out, and (b) to compare those results to when teams had a runner on second and one out, makes the general point pretty well. In fact, Baseball Prospectus has a report that shows that sacrifice bunting reduced a team’s run expectancy for innings that played out that way from .83 runs to .64 runs in 2013. The same is generally true in previous years.
Note too that we’re not talking here about difficult concepts or high-level math. It’s just a simple calculation — more teams scored and scored more with runners on first and nobody out by not-bunting than by bunting. Easy.
But not to Texas Rangers manager Ron Washington. Washington likes to sacrifice bunt. In response to a question about the dubious nature of that strategy based upon the math, Washington took offense.
“I think if they try to do that, they’re going to be telling me how to [bleep] manage,” Washington said. “That’s the way I answer that [bleep] question. They can take the analytics on that and shove it up their [bleep][bleep].”
Wow. He even went third person.
“I do it when I feel it’s necessary, not when the analytics feel it’s necessary, not when you guys feel it’s necessary, and not when somebody else feels it’s necessary. It’s when Ron Washington feels it’s necessary. Bottom line.”
Double wow. No matter one’s chosen ideology, if the data doesn’t support it, the risks of continuing on that path are enormous. It’s not the percentage play (by definition). And it’s not the smart play.
Insisting upon a course of action that is shown to be wrong is, quite simply, a recipe for disaster. A good investment strategy, like good baseball strategy, will be – must be – supported by the data. Reality must rule. When it doesn’t, we’re simply bringing the stupid.
Global climate change is always a hotly debated subject (pardon the pun). The broad and deep consensus of scientists is clear that the change is real, man-made and dangerous. A few critics — largely funded by industries that would be most impacted by the policy changes required to deal effectively with climate change — disagree. My view is clear. That said, I readily acknowledge that, while it seems unlikely, the scientific community might be wrong. However, because the magnitude of the stakes are so enormous, it seems obvious to me that we ought to take serious steps to try to mitigate the problem even if the likelihood of error is high. Simply put, if I think that there is even a 10 percent chance that my car would blow up while driving home tonight, I’m not driving the car home.
On the other hand, some activists trying to stop climate change remain wildly unrealistic. It isn’t likely that many of us will be anxious dramatically to change our standards of living for a nebulous and seemingly far-off consequence. In my view, the most promising possibility for dealing with climate change is technological advance that makes carbon emissions obsolete.
The current issue of The New Yorker examines, in great depth, the challenges, difficulties, prospects and frustrations of the International Thermonuclear Experimental Reactor project, a 35-nation effort that is perhaps our best opportunity to “change the game” technologically. I encourage you to read it. A taste follows.
With an Apollo-like commitment, Janeschitz told me, fusion’s remaining problems could be worked out within a lifetime. But the funding would need to come in significant amounts, and mostly at once, not dribbled over decades. As he sketched out his vision, he alluded to an aphorism by an early Soviet tokamak pioneer, a quote that practically echoes among the halls of ITER’s headquarters: “Fusion will be ready when society needs it.”
Investment Belief #3: We aren’t nearly as rational as we assume
Traditional economic theory insists that we humans are rational actors making rational decisions amidst uncertainty in order to maximize our marginal utility. Sometimes we even try to believe it. But we aren’t nearly as rational as we tend to assume. We frequently delude ourselves and are readily manipulated – a fact that the advertising industry is eager to exploit.1
Watch Mad Men‘s Don Draper (Jon Hamm) use the emotional power of words to sell a couple of Kodak executives on himself and his firm while turning what they perceive to be a technological achievement (the “wheel”) into something much richer and more compelling – the “carousel.”
Those Kodak guys will hire Draper, of course, but their decision-making will hardly be rational. Homo economicus is thus a myth. But, of course, we already knew that. Even young and inexperienced investors can recognize that after just a brief exposure to the real world markets. The “rational man” is as non-existent as the Loch Ness Monster, Bigfoot and (perhaps) moderate Republicans. Yet the idea that we’re essentially rational creatures is a very seductive myth, especially as and when we relate the concept to ourselves (few lose money preying on another’s ego). We love to think that we’re rational actors carefully examining and weighing the available evidence in order to reach the best possible conclusions.
Oh that it were so. If we aren’t really careful, we will remain deluded that we see things as they really are. The truth is that we see things the way we really are. I frequently note that investing successfully is very difficult. And so it is. But the reasons why that is so go well beyond the technical aspects of investing. Sometimes it is retaining honesty, lucidity and simplicity – seeing what is really there – that is what’s so hard. Continue reading
Investment Belief #2: Smart Investing is Reality-Based
Anytime is a good time to talk baseball. I’ve done it pretty much my whole life. If you’re watching a game, its pace is perfectly conducive to discussing (arguing about) players, managers, strategy, tactics, the standings, the pennant races, the quality of ballpark peanuts, and pretty much anything else. In the off-season, the “hot stove league” allows for myriad possible conversations (arguments) about how to make one’s favorite team better. And now that spring training camps have opened, baseball talk about the upcoming season and its prospects has officially begun again in earnest. The coming of Spring means the return of hope — maybe this will finally be the year (Go Padres!) — which of course means talking (arguing) about it.
Our neighborhood quarrels about the National Pastime when I was a kid were incessant and invigorating, and didn’t have to include the vagaries of team revenues and revenue-sharing, player contracts, free agency and the luxury tax, as they do now. We could focus on more important stuff. Who should be the new catcher? Who should we trade for? Do we have any hot phenoms? Who’s the best player? The best pitcher? The best hitter? The best third baseman? Who belongs in the Hall of Fame? Which team will win at all this year? How do the new baseball cards look? Is the new Strat-O-Matic edition out yet?
Early on, my arguments were rudimentary and, truth be told, plenty stupid. They were ideological (the players on my team were always better than those on your team), authority-laden (“The guy in the paper says…”), narrative-driven (“Remember that time…”), overly influenced by the recent (“Did you see what Jim Northrup did last night?”) and loaded with confirmation bias.
Quickly I came to realize that it’s really hard to change an entrenched opinion, and not just because I was arguing with dopes. Slowly it became clear that if I wanted to have at least a chance of winning my arguments, I needed to argue for a position that was reality-based. I needed to bring facts, data and just-plain solid evidence to the table if I wanted to make a reasonable claim to being right, much less of convincing anyone. Arguments and beliefs that are not reality-based are bound to fail, and to fail sooner rather than later.
Michelle Pfeiffer was and is a major movie star. People magazine put her on the cover for its first “50 Most Beautiful People” issue. The New York Times, no less, called her “devastatingly gorgeous.” So when Esquire magazine’s December 1990 cover asked “What Michelle Pfeiffer Needs …,” the answer printed on the inside front cover—“Is Absolutely Nothing”—seemed superfluous at best. However, as it turned out, she needed a lot of help to look like she did on that cover, which was perfect.
I hope you enjoy it.