The Value Project

There is a famous story, almost surely apocryphal, that makes the rounds with some regularity in our industry.  As the story goes, a new, struggling advisor buys a mailing list of 10,000 potential prospects. He then writes two separate newsletters about the same, high beta stock. One newsletter advises a leveraged short of the stock and is sent to half of the list. The other newsletter suggests a leveraged buy of the same stock, and is sent to the other 5,000 prospects.

A month later, the prospects that got the newsletter touting the wrong side of the trade are discarded. The 5,000 that were on the right side are split into two groups and the same process is repeated with a different stock. He does the same thing again two more times.  At the end of four months, the advisor has a list of 625 prospects who can’t believe their luck in finding the next Michael Burry (or Seth Klarman or Warren Buffett).  Of course, they will also spend the next ten years wondering why, after they transferred their life savings, the magic disappeared.

Remember this story every time you consider a money manager or fund’s performance history or think about another “hot” pundit’s recommendations in print or on business television. The markets are binary.  They can only go up or down and are in this way similar to a coin toss, at least in the sense of probability. The odds of getting four calls in a row right are actually fairly low: 0.5*0.5*0.5*0.5 = 6.25% probability. Similarly, if we started with a group of 1,024 people and had them pair off and compete in coin tosses with the winners advancing, by the time we reached the ultimate winner, she would have won 10 contests in a row.  That’s a result that is nearly as unlikely in the particular as it is inevitable in the aggregate.  Good performance alone – even over significant time periods – is not enough to recommend a money manager or fund. 

None of this is to suggest that every manager with good performance is just lucky.  It is merely representative of the hurdles in the way of advisors searching for managers that are actually good at their jobs and not just rolling the dice. Past performance, as we are taught, is no indicator of future results.  Investing skill is – at a minimum – very hard to find.

This multiple-part project is designed to try to ascertain where and how value in the markets may be found. I hope you enjoy it.

The Value Project

The Value Project (2): Commit to Diversification

The Value Project (3): The Value Proposition

The Value Project (4): Emphasize Process

The Value Project (5): Other Stuff

The Value Project (6): Recognizing Value