Financial markets have been roiled in 2016 on fears that China's economy continues to slow, and that the Fed will pursue a more hawkish tightening path than anticipated (the two are related, indirectly by the Fed's status as a monetary superpower, and directly by the RMB's link to the dollar). It has once again been a time to reflect on the challenges a fundamental investor faces. Macroeconomic concerns are hard to weigh when you're considering places like the US, and considerably more so when you're trying to assess an opaque economy in transition like China. So should an investor simply throw his hands up in the air?
I see a few potential strategies.
1. Learn all you can about macro. In his outstanding paper "Investing in the Unknown and Unknowable", Richard Zeckhauser notes the outsize returns to investors who can marshal complementary skills. Being a sophisticated macro observer has always seemed to me one such complementary skill. Some of the greatest trades of all time incorporate macro elements, whether intended or not. But I suggest with this a fair amount of trepidation. First, much of macro is unpredictable, and the product of a complex adaptive system, so it seems like a poor use of time trying to analyze it. Second, even where macro knowledge is helpful, there is a trade-off of time spent on macro analysis vs. asset-level analysis (such as knowing more about a company whose stock you own). Third, an excessive focus on macro fluctuations can lead to distraction from long-term trends, and prevent fundamental investors from appreciating the positive outlook for assets. So, perhaps the best idea is to focus on understanding the long-term drivers of economic growth, and to avoid being swept up by emotion during cyclical booms and busts.
2. Invest in assets that are relatively insensitive to economic fluctuations. There are two variants of this strategy. The first is to invest in assets whose prices are relatively stable. This will likely lead an investor into low return strategies like investing in government bonds. For obvious reasons, I don't recommend this, even if it will help you sleep better at night! The second variant is to look for assets whose prospects are relatively bounded in a variety of economic scenarios (note there is often a great deal of overlap between these two variants: it is precisely their occasional divergence that is worth exploiting). The traditional version of this is to invest in various types of utilities. But there are obviously many high quality businesses out there who are resilient to most economic downturns, through a combination of competitive positioning and financial strength. These businesses generally trade at premium valuations (i.e. with low implied returns) for that reason, so when they go on sale, it's best to be prepared to act swiftly.
3. Be realistic. Understand that there will be ups and downs in any portfolio. Just as important, one has to differentiate between forgivable and unforgivable mistakes. Or, to draw a parallel to Roman Catholicism, we should differentiate between venial and mortal sins in investing. Charlie Munger has a great quote: "I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn." But there's a limit to how harsh we should be with ourselves. I'm constantly wary of being a pattern-seeking, story-telling animal. It's okay not to know whether Chinese growth will be 3% or 6%. It is much less okay to lose money on a company that is modestly cheap if Chinese growth is 6% and in dire straits if growth is 3%.
If I had to highlight one unforgivable sin in investing, it is getting swept up by emotion at market tops or bottoms (only identifiable in retrospect, unfortunately). But what's worse is that we have a tendency to compound these errors. It is really, really not okay to lose sight of the long-term prospects of a wonderful business, sell one's stake in that business, and compound that error by refusing to buy at a higher price. So, if you make a mistake, so be it - wipe the slate clean, lest a venial sin turn into a mortal one.
I wish all readers a happy, productive and - just maybe - sin-free 2016.
P.S. John Huber has an excellent post touching on some similar themes.
Saturday, January 16, 2016
Monday, December 21, 2015
Books I Enjoyed In 2015
The end of the year is rapidly approaching, and it looks unlikely I'm going to add to this list in the next few days. I modified this list somewhat from last year's in that I decided to include titles that I wasn't reading for the first time. I define "2015 Favourites" as books I can see myself re-reading, while "Honourable Mention" names are things I enjoyed but am unlikely to tackle again. Happy reading, and a very happy end to 2015 to one and all!
2015 Favourites
The Incredible Shrinking Alpha (Swedroe & Berkin): A quick and readable survey of the challenges facing active asset management. Anyone engaged in active management simply must grapple with these issues, as a matter of intellectual and professional honesty as well as to consider the business challenge posed by passive management strategies (be they indexers or rules-based quantitative strategies). Swedroe is a good follow on Twitter too.
The Greatest Trade Ever (Zuckerman): I have a longer post on this one, but it's just a terrific read to understand John Paulson's stupendous success in profiting from the housing debacle of 2007-2009. As I say in the other post, it's hard to write a page-turner about credit derivatives, but Zuckerman does an amazing job.
Efficiently Inefficient (Pedersen): This is a clear and entertaining read on hedge fund strategies. It features interviews with some of the leading lights in the hedge fund world, though I must confess I was a little disappointed with some of the interviews. The main material is excellent, though.
Becoming Human (Vanier): I first heard of Jean Vanier through an "On Being" interview. A philosopher and Catholic social innovator, he started the L'Arche movement for people with intellectual disabilities. His simplicity and compassion were deeply moving.
The Dhandho Investor (Pabrai): I have long heard of Pabrai's book, and finally got round to it this year. I wish I'd read it earlier. It's funny and readable, but a deeply wise book on value investing. His mantra of "Heads I win, tails I don't lose much!" is as good an explanation of how to think about achieving asymmetry in investing as you'll hear anywhere.
The Art of Charlie Chan Hock Chye (Liew): In a year when my beloved Singapore celebrated her 50th anniversary as an independent nation, this sharp graphic novel traces the country's history in parallel with a fictional graphic artist.
The Looming Tower (Wright): Everyone wanted to talk about ISIS this year, but I was a few steps behind. I bought this thinking it was an account of the 9/11 attacks, but it was much, much more. A wonderfully crisp read on the rise of modern Islamic fundamentalism and al-Qaeda.
The Outsiders (Thorndike): An excellent book on how contrarian CEOs created shareholder value, recommended by no less a luminary than Warren Buffett. It's a shame that most CEOs (and boards) think "capital allocation" = doing share buybacks when their stock is at record highs, rather than when it's the most accretive to shareholders.
Buddhism Without Beliefs (Batchelor): Batchelor is one of the giants of secular Buddhism, the movement that distills the wisdom of Buddhist thought while shedding traditional Buddhist ritual and beliefs on cosmology and reincarnation. In this volume, he makes a strong case for understanding the historical and social context in which Buddhism developed. As good as I remembered the second time round.
A Guide to the Good Life (Irvine): This is a wonderful introduction to Stoic philosophy, updating an obscure and misunderstood set of beliefs for modern times. The parallels between Stoicism and Buddhism are interesting, and goes to show you can find wisdom in disparate places if you look hard enough.
Superforecasting (Tetlock): Quite simply a must-read on decision-making and prediction. I think this is one I will read and refer to many, many more times.
The Alliance/ The Start-up of You (Hoffman/Casnocha): I enjoyed these two books by the LinkedIn founders. At times they seem a little too much like ads for LinkedIn, but I think there's a lot of wisdom in here about how to think about careers and organizations in the modern world.
The Essays of Warren Buffett: Buffett is so well-covered that it was hard to imagine that there would be much original in this collection, but I still found it useful and insightful. I did a longer post on the key messages.
Honourable Mention
Exorbitant Privilege (Eichengreen): It's really hard to write a book on the international monetary system for popular consumption. I think Eichengreen does a pretty good job here, although some may prefer a deeper look at specific events (e.g. Ahamed's Lords of Finance and Connolly's Rotten Heart of Europe). Reading it in 2015, it's funny how the book was written at a period of extreme concern about the dollar - something which seems to have vanished from the mainstream. But who knows what people will say in 5-10 years?
Poor Economics (Duflo & Banerjee): I've been hearing about Duflo & Banerjee's work for years, and enjoyed their take on the global fight against poverty. So much of what we think we know about poverty, and the poor, seems to be wrong, but it's gratifying to see people tackling the field in novel ways.
The Hard Thing About Hard Things: Entrepeneur and venture capitalist Ben Horowitz writes about his experiences in the business world. There are some great anecdotes and lessons here. Definitely one for those interested in start-up world.
Leaving Alexandria (Holloway): I've had this on my reading list for ages. In 2003 or so, I discovered a book called "Godless Morality", and was stunned to discover the author was the Bishop of Edinburgh. Since then I have been an avid consumer of Holloway's talks. This autobiography details his eventual departure from the church. While my thinking on religion is more in line with Holloway than Vanier, I preferred the simplicity of the latter's prose. Still, there was much to appreciate here.
The Novice (Schettini): Continuing the theme of those who had given up the robes, Schettini recounts his life as a Buddhist monk. Like Holloway's book, there was much to enjoy, even if the prose wasn't always quite to my taste. The epilogue was my favorite part of this, with Schettini describing the changes in his life after giving up the robes. A shame it's a relatively small part of the book, but it would be impossible to really understand without hearing first about his prior journey.
Benjamin Graham and the Power of Growth Stocks (Martin): This is an unusual take on Ben Graham as a growth investor. Martin argues that the 1962 edition of Security Analysis reveals Graham's shift in investment philosophy.
Damn Right! (Lowe): I hadn't read this since 2006, but decided to pick it up again as I re-explored the value investing classics. I found I enjoyed it less than I remembered. It's possible that Munger has become such a popular subject in the past 9 years that this edition no longer seems quite as original. Still, always worth a read for Buffett/Munger fans. And for those relatively new to the world of investments, it's a wonderful reminder that Munger didn't meet (and go into business with) Buffett till he was 36 years old, which seems positively ancient in the modern age of 30 year-old hedge fund wunderkinds.
The Education of a Value Investor (Spier): Part autobiography, part investment guidebook, part discourse on the good life. Spier's honesty was refreshing. This led me to Pabrai's book. The friendship between the two investors inspired a longer post as well.
2015 Favourites
The Incredible Shrinking Alpha (Swedroe & Berkin): A quick and readable survey of the challenges facing active asset management. Anyone engaged in active management simply must grapple with these issues, as a matter of intellectual and professional honesty as well as to consider the business challenge posed by passive management strategies (be they indexers or rules-based quantitative strategies). Swedroe is a good follow on Twitter too.
The Greatest Trade Ever (Zuckerman): I have a longer post on this one, but it's just a terrific read to understand John Paulson's stupendous success in profiting from the housing debacle of 2007-2009. As I say in the other post, it's hard to write a page-turner about credit derivatives, but Zuckerman does an amazing job.
Efficiently Inefficient (Pedersen): This is a clear and entertaining read on hedge fund strategies. It features interviews with some of the leading lights in the hedge fund world, though I must confess I was a little disappointed with some of the interviews. The main material is excellent, though.
Becoming Human (Vanier): I first heard of Jean Vanier through an "On Being" interview. A philosopher and Catholic social innovator, he started the L'Arche movement for people with intellectual disabilities. His simplicity and compassion were deeply moving.
The Dhandho Investor (Pabrai): I have long heard of Pabrai's book, and finally got round to it this year. I wish I'd read it earlier. It's funny and readable, but a deeply wise book on value investing. His mantra of "Heads I win, tails I don't lose much!" is as good an explanation of how to think about achieving asymmetry in investing as you'll hear anywhere.
The Art of Charlie Chan Hock Chye (Liew): In a year when my beloved Singapore celebrated her 50th anniversary as an independent nation, this sharp graphic novel traces the country's history in parallel with a fictional graphic artist.
The Looming Tower (Wright): Everyone wanted to talk about ISIS this year, but I was a few steps behind. I bought this thinking it was an account of the 9/11 attacks, but it was much, much more. A wonderfully crisp read on the rise of modern Islamic fundamentalism and al-Qaeda.
The Outsiders (Thorndike): An excellent book on how contrarian CEOs created shareholder value, recommended by no less a luminary than Warren Buffett. It's a shame that most CEOs (and boards) think "capital allocation" = doing share buybacks when their stock is at record highs, rather than when it's the most accretive to shareholders.
Buddhism Without Beliefs (Batchelor): Batchelor is one of the giants of secular Buddhism, the movement that distills the wisdom of Buddhist thought while shedding traditional Buddhist ritual and beliefs on cosmology and reincarnation. In this volume, he makes a strong case for understanding the historical and social context in which Buddhism developed. As good as I remembered the second time round.
A Guide to the Good Life (Irvine): This is a wonderful introduction to Stoic philosophy, updating an obscure and misunderstood set of beliefs for modern times. The parallels between Stoicism and Buddhism are interesting, and goes to show you can find wisdom in disparate places if you look hard enough.
Superforecasting (Tetlock): Quite simply a must-read on decision-making and prediction. I think this is one I will read and refer to many, many more times.
The Alliance/ The Start-up of You (Hoffman/Casnocha): I enjoyed these two books by the LinkedIn founders. At times they seem a little too much like ads for LinkedIn, but I think there's a lot of wisdom in here about how to think about careers and organizations in the modern world.
The Essays of Warren Buffett: Buffett is so well-covered that it was hard to imagine that there would be much original in this collection, but I still found it useful and insightful. I did a longer post on the key messages.
Honourable Mention
Exorbitant Privilege (Eichengreen): It's really hard to write a book on the international monetary system for popular consumption. I think Eichengreen does a pretty good job here, although some may prefer a deeper look at specific events (e.g. Ahamed's Lords of Finance and Connolly's Rotten Heart of Europe). Reading it in 2015, it's funny how the book was written at a period of extreme concern about the dollar - something which seems to have vanished from the mainstream. But who knows what people will say in 5-10 years?
Poor Economics (Duflo & Banerjee): I've been hearing about Duflo & Banerjee's work for years, and enjoyed their take on the global fight against poverty. So much of what we think we know about poverty, and the poor, seems to be wrong, but it's gratifying to see people tackling the field in novel ways.
The Hard Thing About Hard Things: Entrepeneur and venture capitalist Ben Horowitz writes about his experiences in the business world. There are some great anecdotes and lessons here. Definitely one for those interested in start-up world.
Leaving Alexandria (Holloway): I've had this on my reading list for ages. In 2003 or so, I discovered a book called "Godless Morality", and was stunned to discover the author was the Bishop of Edinburgh. Since then I have been an avid consumer of Holloway's talks. This autobiography details his eventual departure from the church. While my thinking on religion is more in line with Holloway than Vanier, I preferred the simplicity of the latter's prose. Still, there was much to appreciate here.
The Novice (Schettini): Continuing the theme of those who had given up the robes, Schettini recounts his life as a Buddhist monk. Like Holloway's book, there was much to enjoy, even if the prose wasn't always quite to my taste. The epilogue was my favorite part of this, with Schettini describing the changes in his life after giving up the robes. A shame it's a relatively small part of the book, but it would be impossible to really understand without hearing first about his prior journey.
Benjamin Graham and the Power of Growth Stocks (Martin): This is an unusual take on Ben Graham as a growth investor. Martin argues that the 1962 edition of Security Analysis reveals Graham's shift in investment philosophy.
Damn Right! (Lowe): I hadn't read this since 2006, but decided to pick it up again as I re-explored the value investing classics. I found I enjoyed it less than I remembered. It's possible that Munger has become such a popular subject in the past 9 years that this edition no longer seems quite as original. Still, always worth a read for Buffett/Munger fans. And for those relatively new to the world of investments, it's a wonderful reminder that Munger didn't meet (and go into business with) Buffett till he was 36 years old, which seems positively ancient in the modern age of 30 year-old hedge fund wunderkinds.
The Education of a Value Investor (Spier): Part autobiography, part investment guidebook, part discourse on the good life. Spier's honesty was refreshing. This led me to Pabrai's book. The friendship between the two investors inspired a longer post as well.
Monday, November 2, 2015
Pattern-Seeking, Story-Telling Animals
One of my favourite quotes about macroeconomics comes from Ed Leamer, who wrote, "We are pattern-seeking story-telling animals." The brilliance of this quote (which he originally heard from a radio commentator) is that it applies to many other aspects of human thought, such as physical and social science, as well as religion. I've been thinking this week about the ways in which we seek patterns and tell stories, both in trying to understand past events and trying to predict future ones. The original impetus was a captivating talk by Bruce Riedel on JFK and the Sino-Indian crisis of 1962. One of the most remarkable things about this crisis is how many unanswered questions remain, despite it involving some of the world's largest and most scrutinized countries, and the passage of more than 50 years. Many questions will never be answered. These are the hypothetical "what if?" questions that are amusing fodder for speculation but will never be answered definitively.
I was reminded of a wonderful passage from Ed Catmull's "Creativity, Inc." (a book I wrote more about last year). Catmull writes:
"In thinking about...the limits of our perception, a familiar, oft-repeated phrase kept popping into my head: "Hindsight is 20-20." When we hear it, we normally just nod in agreement - yes, of course - accepting that we can look back on what happened, see it with total clarity, learn from it and draw the right conclusions.
The problem is, the phrase is dead wrong. Hindsight is not 20-20. Not even close. Our view of the past, in fact, is hardly clearer than our view of the future. While we know more about a past event than a future one, our understanding of the factors that shaped it is severely limited. Not only that, because we think we see what happened clearly - hindsight being 20-20 and all - we often aren't open to knowing more. "We should be careful to get out of an experience only the wisdom that is in it - and stop there," as Mark Twain once said, "lest we be like the cat that sits down on a hot stove-lid. She will never sit down on a hot stove-lid again - and that is well; but also she will never sit down on a cold one anymore." The cat's hindsight, in other words, distorts her view. The past should be our teacher, not our master."
The Catmull quote identifies 2 distinct issues related to hindsight:
1) Looking back and thinking something was obvious, when it wasn't
2) Looking back and drawing the wrong lesson, i.e. that the future will resemble the past.
It's easy to look back at a 10-year chart of the S&P and think to oneself how easy it should have been to have picked the bottom on Mar 6 2009. Indeed, I have lauded the courage of investors who were steadfastly buying cheap securities in the face of financial panic. But only some of these people are worthy of praise. I think of these as mainly being (a) those who made well-reasoned estimates of valuation, (b) those who understood the likely mechanisms of QE and Fed policy, and (c) those who, for other, thoughtful reasons decided that the odds of investing were in their favour. The common thread is that these groups relied on facts as the inputs to weigh the odds of investing. This is intelligent speculation rather than hopeful gambling.
The fact of the matter is that it was far from clear that the economic and financial panic were over. Most investors faced genuine uncertainty as to the efficacy of Federal Reserve policies, and the implications for financial assets. One of many communication problems we have in finance is the double meaning of the word "cheap". Some mean it to mean "low-priced". Many mean it to denote "lower than fair value". I prefer the latter definition, and by that definition, assets are cheapest not when their prices are the lowest, but when their prices deviate most significantly from an informed view of their true value. Apart from the groups listed above, there are others who may have bought in the depths of 2009, but were merely lucky (or perhaps foolhardy). For some, the lesson was to buy the dip, and in particular the most leveraged, economically sensitive assets. I hardly recommend that lesson. For others, hindsight has taken the form of stricter drawdown control measures, and a heightened jumpiness when faced with any market turbulence. These nervous investors seem sure to forego the benefits of long-term compounding as they sell winners prematurely.
It seems to be that the follies of hindsight and extrapolation are closely related. John Templeton reportedly said that the four most dangerous words in investing are "This time it's different." This is usually taken to mean that only the foolish ignore the fact that asset prices are cyclical, and mean-reverting. To me, this is second-order thinking and assumes the deluded investor has enough knowledge of history to believe that this time will be different. I actually think most people respond in a far simpler fashion. The more dangerous words for them are "this will go on". Most people are probably not as greedy as we may them out to be after the bust. Rather, they make the perfectly understandable error that the future will look similar to the recent past. Nominal GDP will grow at rates similar to the past. Interest rates will look similar to the past. Corporate profits and economic moats will look like they did in the past. Markets will look like they did in the past (up, down or flat depending what they looked like most recently). Megan McArdle had it spot on when she wrote: "Bubbles are not fundamentally about evil people doing evil things. They are not even about stupid people doing stupid things. No, the problem with bubbles is worse: It's quite ordinary people, doing stupid things that a trick of the light has made appear very smart."
I don't have any bold prescriptions for these problems. Acting in an unknown and unknowable environment is the central problem of investing. I defer here to the thinking of Richard Zeckhauser, who says some very interesting things in "Investing in the Unknown and Unknowable" (some of which the most conservative value investors will disagree with). Nassim Taleb is clearly another deep thinker on these issues. My modest additions include the recommendation to document our beliefs in real time, and judge ourselves honestly on how events match up to our predictions. Another of my favourite quotes is physicist Richard Feynman:"The first principle is that you must not fool yourself - and you are the easiest person to fool." It's also an argument for focusing on process, rather than individual outcomes. But again, caution is warranted: the process should be well thought through, and not merely "Sell when the market is down X%" (the investor's version of "Don't sit on stove-lids"). This focus on process makes us simultaneously harsher on ourselves, when we've been lucky rather than good, and more forgiving, when we made the best possible (but ultimately wrong) decision with the information available. If we can avoid getting knocked out of the game on any one bet, a robust process should deliver returns over time.
But don't take it from me. I'm just another pattern-seeking, story-telling animal.
I was reminded of a wonderful passage from Ed Catmull's "Creativity, Inc." (a book I wrote more about last year). Catmull writes:
"In thinking about...the limits of our perception, a familiar, oft-repeated phrase kept popping into my head: "Hindsight is 20-20." When we hear it, we normally just nod in agreement - yes, of course - accepting that we can look back on what happened, see it with total clarity, learn from it and draw the right conclusions.
The problem is, the phrase is dead wrong. Hindsight is not 20-20. Not even close. Our view of the past, in fact, is hardly clearer than our view of the future. While we know more about a past event than a future one, our understanding of the factors that shaped it is severely limited. Not only that, because we think we see what happened clearly - hindsight being 20-20 and all - we often aren't open to knowing more. "We should be careful to get out of an experience only the wisdom that is in it - and stop there," as Mark Twain once said, "lest we be like the cat that sits down on a hot stove-lid. She will never sit down on a hot stove-lid again - and that is well; but also she will never sit down on a cold one anymore." The cat's hindsight, in other words, distorts her view. The past should be our teacher, not our master."
The Catmull quote identifies 2 distinct issues related to hindsight:
1) Looking back and thinking something was obvious, when it wasn't
2) Looking back and drawing the wrong lesson, i.e. that the future will resemble the past.
It's easy to look back at a 10-year chart of the S&P and think to oneself how easy it should have been to have picked the bottom on Mar 6 2009. Indeed, I have lauded the courage of investors who were steadfastly buying cheap securities in the face of financial panic. But only some of these people are worthy of praise. I think of these as mainly being (a) those who made well-reasoned estimates of valuation, (b) those who understood the likely mechanisms of QE and Fed policy, and (c) those who, for other, thoughtful reasons decided that the odds of investing were in their favour. The common thread is that these groups relied on facts as the inputs to weigh the odds of investing. This is intelligent speculation rather than hopeful gambling.
The fact of the matter is that it was far from clear that the economic and financial panic were over. Most investors faced genuine uncertainty as to the efficacy of Federal Reserve policies, and the implications for financial assets. One of many communication problems we have in finance is the double meaning of the word "cheap". Some mean it to mean "low-priced". Many mean it to denote "lower than fair value". I prefer the latter definition, and by that definition, assets are cheapest not when their prices are the lowest, but when their prices deviate most significantly from an informed view of their true value. Apart from the groups listed above, there are others who may have bought in the depths of 2009, but were merely lucky (or perhaps foolhardy). For some, the lesson was to buy the dip, and in particular the most leveraged, economically sensitive assets. I hardly recommend that lesson. For others, hindsight has taken the form of stricter drawdown control measures, and a heightened jumpiness when faced with any market turbulence. These nervous investors seem sure to forego the benefits of long-term compounding as they sell winners prematurely.
It seems to be that the follies of hindsight and extrapolation are closely related. John Templeton reportedly said that the four most dangerous words in investing are "This time it's different." This is usually taken to mean that only the foolish ignore the fact that asset prices are cyclical, and mean-reverting. To me, this is second-order thinking and assumes the deluded investor has enough knowledge of history to believe that this time will be different. I actually think most people respond in a far simpler fashion. The more dangerous words for them are "this will go on". Most people are probably not as greedy as we may them out to be after the bust. Rather, they make the perfectly understandable error that the future will look similar to the recent past. Nominal GDP will grow at rates similar to the past. Interest rates will look similar to the past. Corporate profits and economic moats will look like they did in the past. Markets will look like they did in the past (up, down or flat depending what they looked like most recently). Megan McArdle had it spot on when she wrote: "Bubbles are not fundamentally about evil people doing evil things. They are not even about stupid people doing stupid things. No, the problem with bubbles is worse: It's quite ordinary people, doing stupid things that a trick of the light has made appear very smart."
I don't have any bold prescriptions for these problems. Acting in an unknown and unknowable environment is the central problem of investing. I defer here to the thinking of Richard Zeckhauser, who says some very interesting things in "Investing in the Unknown and Unknowable" (some of which the most conservative value investors will disagree with). Nassim Taleb is clearly another deep thinker on these issues. My modest additions include the recommendation to document our beliefs in real time, and judge ourselves honestly on how events match up to our predictions. Another of my favourite quotes is physicist Richard Feynman:"The first principle is that you must not fool yourself - and you are the easiest person to fool." It's also an argument for focusing on process, rather than individual outcomes. But again, caution is warranted: the process should be well thought through, and not merely "Sell when the market is down X%" (the investor's version of "Don't sit on stove-lids"). This focus on process makes us simultaneously harsher on ourselves, when we've been lucky rather than good, and more forgiving, when we made the best possible (but ultimately wrong) decision with the information available. If we can avoid getting knocked out of the game on any one bet, a robust process should deliver returns over time.
But don't take it from me. I'm just another pattern-seeking, story-telling animal.
Monday, October 19, 2015
The Third Emotion of Investing
It's often said that financial markets are driven by two competing emotions, greed and fear. Skilled investors attempt to control these emotions, and to capitalize on the failure of other investors in that regard. Warren Buffett has repeatedly said that while he focuses on fundamental value, his behaviour is dictated by a simple dictum: "Be fearful when others are greedy, and be greedy when others are fearful."
There's a third emotion that requires constant management: boredom.
It's exciting when assets go up or down by a lot. Generally, they don't. It's boring to watch things that don't do much in a hurry. And it's boring to wait for the market to validate your assessment of fundamental value.
It's boring to sift through financial statements or filings and then discover a company is fairly valued. It's boring to wait for a better opportunity to purchase an asset. It's boring to own a company that has excellent prospects but that no-one has ever heard of (or is likely to ever hear of). It's boring to remain invested in a company that is quietly compounding its value (and whose business you understand well), when new opportunities appear more alluring. It's boring to invest the same way you always have, when the world around is full of "sophisticated" investors raising a lot of money for complex strategies.
Sitting through long periods of boredom is a prerequisite for the fundamental investor. Dealing with this boredom is every bit as important as avoiding being swept away when valuations are high, or being decisive when it seems like businesses, economies or financial markets will never improve.
Pascal said, "All men's miseries derive from not being able to sit in a quiet room alone." I doubt he had investment portfolios in mind, but subduing the third emotion of investing goes a long way to preventing misery of the financial variety.
There's a third emotion that requires constant management: boredom.
It's exciting when assets go up or down by a lot. Generally, they don't. It's boring to watch things that don't do much in a hurry. And it's boring to wait for the market to validate your assessment of fundamental value.
It's boring to sift through financial statements or filings and then discover a company is fairly valued. It's boring to wait for a better opportunity to purchase an asset. It's boring to own a company that has excellent prospects but that no-one has ever heard of (or is likely to ever hear of). It's boring to remain invested in a company that is quietly compounding its value (and whose business you understand well), when new opportunities appear more alluring. It's boring to invest the same way you always have, when the world around is full of "sophisticated" investors raising a lot of money for complex strategies.
Sitting through long periods of boredom is a prerequisite for the fundamental investor. Dealing with this boredom is every bit as important as avoiding being swept away when valuations are high, or being decisive when it seems like businesses, economies or financial markets will never improve.
Pascal said, "All men's miseries derive from not being able to sit in a quiet room alone." I doubt he had investment portfolios in mind, but subduing the third emotion of investing goes a long way to preventing misery of the financial variety.
Sunday, October 11, 2015
Sometimes An Investor Wears A Mask So Long...
The debate over "nature vs. nurture" pervades biological science and the social sciences. Unsurprisingly, the debate even wends its way into the world of investing. Are great investors born, or can they be moulded? In a previous post, I took issue with Warren Buffett's search for "someone genetically programmed to recognize and avoid serious risks" (emphasis mine). But Buffett himself has always been a proponent of how investors - and people, more generally - can change themselves through the force of habit. In a speech to business school students, he said "You can't change the way you were wired much, but you can change a lot of what you do with that wiring. It's the habits you generate that matter." I watched that speech on YouTube maybe seven years ago, and was deeply struck by this multi-billionaire preaching the virtue of habits and character, rather than cutthroat competition or iridescent intellect, as the way to success.
I consider myself pretty firmly in the habit-forming camp. Many of you have probably seen hackneyed secret agent/undercover cop movies, and heard some version of the cliche "Sometimes a person wears a mask so long, he doesn't know which one is his real face." That's usually meant to convey the costs of duplicity, but the flipside of that seems true to me as well: act in the appropriate way (despite your instincts to do otherwise), and eventually that will become second nature. Easier said than done, perhaps, but it still seems true. As with investing and corporate strategy, a long horizon helps. For example, business strategy researcher Robert M. Grant recommends taking an inventory of a firm's resources and capabilities as a start to formulating corporate strategy. Then, he suggests (a) exploiting key strengths, (b) managing key weaknesses, and (c) capitalizing on "superfluous strengths" (more on this below). He notes, "Converting weakness into strength is likely to be a long-term task for most companies. In the short to medium term, a company is likely to be stuck with the resources and capabilities that it inherits from the previous period." The same is true for individuals.
That said, I don't think that it's a simple matter of identifying one's bad habits, targeting good habits, and then replacing the bad with the good. Rather, it is a constant and dynamic process of change and growth. My thinking on this has been influenced by a variety of sources:
- Neuroplasticity, i.e. the notion that the brain is constantly changing and rewiring itself
- Growth mindset, i.e. Carol Dweck's work on how attitude shapes success.
- Non-self (or anatta), i.e. a tenet of Buddhist thought, which, in the words of Stephen Batchelor, focuses on "an authentic vision of the changing, contingent, and creative character of ourselves and the world"
Given these prior beliefs, I see these precepts in action everywhere. Over the past 2 weeks alone, I came across examples which supported my notion (possibly confirmation bias, I'll admit!):
- Kaizen, i.e. the Japanese philosophy of continuous improvement
- Life as improvisational art, in the words of writer Mary Catherine Bateson
- "Superforecasters" - as written about by Philip Tetlock and Dan Gardner, and summarized by Michael Maubossin - who see themselves as being in perpetual beta mode, constantly updating their knowledge and revising their beliefs. (Side note: If I were ever to get a tattoo, a pretty strong contender would have to be, "Beliefs are hypotheses to be tested, not treasures to be protected.")
- Sufi poet Rumi: "Yesterday I was clever, so I wanted to change the world. Today I am wise, so I am changing myself."
I don't want to give the impression that I discount "nature" completely. In a prior post, I referred to investor Guy Spier. Spier has gone so far as to place a bronze bust of Charlier Munger in his office, while simultaneously acknowledging that he will never be Munger or Buffett, and can only be the best version of himself. I, similarly, have spent a great deal of time thinking about how best to achieve high risk-adjusted returns in a manner that is both in line with my personal temperament and actually fun.
And yet even these inherent characteristics can be harnessed creatively. Again, there are parallels with corporate strategy. As mentioned earlier, Grant suggests (a) exploiting key strengths, (b) managing key weaknesses, and (c) capitalizing on "superfluous strengths". As an example of (b), he cites Harley-Davidson, who is unable to compete with Honda and Yamaha on technology, and has instead chosen to make a virtue out of its outmoded technology and traditional designs as a key part of the Harley-Davidson experience. Item (c) refers to developing innovative strategies that turn apparently inconsequential strengths into key strategy differentiators. As an example of this, he cites the brokerage firm Edward Jones, whose network of brick-and-mortar offices appeared outdated in the Internet era. However, "by emphasizing personal service, trustworthiness, and its traditional, conservative investment virtues, Edward Jones has built a successful contrarian strategy based on its network of local offices."
So if I had to summarize this rambling collection of thoughts, it would be as follows: We have some inherent endowment of qualities, but we can use them creatively, and can in fact change those qualities far beyond what we thought was possible over a long enough period of time, given sufficient determination. Or perhaps more succinctly, sometimes an investor wears a mask so long, he doesn't know which one is his real face. And that can be a good thing.
I consider myself pretty firmly in the habit-forming camp. Many of you have probably seen hackneyed secret agent/undercover cop movies, and heard some version of the cliche "Sometimes a person wears a mask so long, he doesn't know which one is his real face." That's usually meant to convey the costs of duplicity, but the flipside of that seems true to me as well: act in the appropriate way (despite your instincts to do otherwise), and eventually that will become second nature. Easier said than done, perhaps, but it still seems true. As with investing and corporate strategy, a long horizon helps. For example, business strategy researcher Robert M. Grant recommends taking an inventory of a firm's resources and capabilities as a start to formulating corporate strategy. Then, he suggests (a) exploiting key strengths, (b) managing key weaknesses, and (c) capitalizing on "superfluous strengths" (more on this below). He notes, "Converting weakness into strength is likely to be a long-term task for most companies. In the short to medium term, a company is likely to be stuck with the resources and capabilities that it inherits from the previous period." The same is true for individuals.
That said, I don't think that it's a simple matter of identifying one's bad habits, targeting good habits, and then replacing the bad with the good. Rather, it is a constant and dynamic process of change and growth. My thinking on this has been influenced by a variety of sources:
- Neuroplasticity, i.e. the notion that the brain is constantly changing and rewiring itself
- Growth mindset, i.e. Carol Dweck's work on how attitude shapes success.
- Non-self (or anatta), i.e. a tenet of Buddhist thought, which, in the words of Stephen Batchelor, focuses on "an authentic vision of the changing, contingent, and creative character of ourselves and the world"
Given these prior beliefs, I see these precepts in action everywhere. Over the past 2 weeks alone, I came across examples which supported my notion (possibly confirmation bias, I'll admit!):
- Kaizen, i.e. the Japanese philosophy of continuous improvement
- Life as improvisational art, in the words of writer Mary Catherine Bateson
- "Superforecasters" - as written about by Philip Tetlock and Dan Gardner, and summarized by Michael Maubossin - who see themselves as being in perpetual beta mode, constantly updating their knowledge and revising their beliefs. (Side note: If I were ever to get a tattoo, a pretty strong contender would have to be, "Beliefs are hypotheses to be tested, not treasures to be protected.")
- Sufi poet Rumi: "Yesterday I was clever, so I wanted to change the world. Today I am wise, so I am changing myself."
I don't want to give the impression that I discount "nature" completely. In a prior post, I referred to investor Guy Spier. Spier has gone so far as to place a bronze bust of Charlier Munger in his office, while simultaneously acknowledging that he will never be Munger or Buffett, and can only be the best version of himself. I, similarly, have spent a great deal of time thinking about how best to achieve high risk-adjusted returns in a manner that is both in line with my personal temperament and actually fun.
And yet even these inherent characteristics can be harnessed creatively. Again, there are parallels with corporate strategy. As mentioned earlier, Grant suggests (a) exploiting key strengths, (b) managing key weaknesses, and (c) capitalizing on "superfluous strengths". As an example of (b), he cites Harley-Davidson, who is unable to compete with Honda and Yamaha on technology, and has instead chosen to make a virtue out of its outmoded technology and traditional designs as a key part of the Harley-Davidson experience. Item (c) refers to developing innovative strategies that turn apparently inconsequential strengths into key strategy differentiators. As an example of this, he cites the brokerage firm Edward Jones, whose network of brick-and-mortar offices appeared outdated in the Internet era. However, "by emphasizing personal service, trustworthiness, and its traditional, conservative investment virtues, Edward Jones has built a successful contrarian strategy based on its network of local offices."
So if I had to summarize this rambling collection of thoughts, it would be as follows: We have some inherent endowment of qualities, but we can use them creatively, and can in fact change those qualities far beyond what we thought was possible over a long enough period of time, given sufficient determination. Or perhaps more succinctly, sometimes an investor wears a mask so long, he doesn't know which one is his real face. And that can be a good thing.
Friday, September 25, 2015
Empathy and Investment Management
A curious thing happened to me this morning. As I was walking through the hallway of my apartment building, I noticed that the door to a neighbour's apartment was open. I glanced into the apartment as I passed, and was struck by how different the apartment looked to mine. Despite having similar layouts, the two apartments were (unsurprisingly) furnished and arranged differently. None of this should have come as a surprise to me, but it was still jarring to see an apartment different from the model I had created in my head.
Later on, I was browsing the news and chanced upon a story about the pessimism shrouding Brazil's financial markets. Lamenting the state of Brazil's economy and equity markets, analyst Vitor Suzaki was quoted as saying, "We just can't imagine what kind of news would bring confidence back."
What do these two incidents have in common? In both instances, the people involved appeared to suffer from a distinct lack of imagination, or perhaps an overly narrow perspective. For investors, this flaw can be harmful. Renowned macro trader Bruce Kovner said, "I have the ability to imagine configurations of the world different from today and really believe it can happen." He believed this was an important element of his success.
Sanjay Bakshi refers to a similar concept, which he calls empathy. In a talk entitled "The Prejudices of Mr. Market", he touts empathy as a way for investors to better understand the customers, competitors and executives of businesses they own, as well as other financial market participants.
This comes as a time when empathy, in its more traditional sense, is making a resurgence as a valued skill. Summarizing his new book, "Humans Are Underrated", Geoff Colvin writes, "The evidence is clear that the most effective groups are those whose members most strongly possess the most essentially, deeply human abilities - empathy above all, social sensitivity, storytelling, collaborating, solving problems together, building relationships."
Many fund managers deliberately avoid excessive contact with their underlying investors. There's no doubt that it can be detrimental to a manager's sang-froid (and a drain on scarce time) to be constantly reacting to investors' concerns about volatility in financial markets. Yet at the same time, it's worth remembering that fund managers serve not only to invest wisely, but to shepherd their investors through turbulent times. This involves understanding investors' concerns while effectively communicating a long-term strategy. It seems clear that investment managers who can harness technology - or "race with machines", to quote Brynjolfsson and McAfee, will outperform those who try in vain to race against machines. But the human element of investment management - empathy, communication and leadership - will remain every bit as important. Fund managers will do well to nurture these skills to become better analysts as well as more valuable guides on the treacherous path that is investing.
Sunday, September 6, 2015
The Three Jewels of Investing?
In order to become a Buddhist, one is encouraged to embrace (and "take refuge in") the "Three Jewels", a set of ideals that anchor the individual. The jewels are (1) the Buddha, (2) the Dharma, and (3) the Sangha. The Buddhist Centre describes the Three Jewels more fully as follows:
(1) "Going for Refuge to the Buddha means seeing him as your ultimate teacher and spiritual example. It also means committing yourself to achieving Buddhahood...which means that you aim to become someone who sees the nature of reality absolutely clearly, just as it is, and lives fully and naturally in accordance with that vision."
(2) "The Dharma primarily means the teachings of the Buddha, or the truth he understood. The word 'Dharma' has many meanings but most importantly it means the unmediated Truth (as experienced by the Enlightened mind)... Regarding the Dharma as a refuge means seeing these teachings as the best guide to reality, and committing yourself to practicing them."
(3) "If we are to practice the Dharma we need the example and teaching of others who have done so before us, especially those who have gained insight into the nature of reality themselves. So the third of the Three Jewels is the Sangha or the spiritual community... We need the guidance of personal teachers who are further along the path than we are, and the support and friendship of other practitioners."
I have recently completed a slew of value investing-oriented books, and have been thinking about whether we can formulate a similar Three Jewels of Investing. You'll note that the title of this post is a question, rather than a statement. It would be immense hubris to pretend that I had uncovered something on the order of importance of the original Three Jewels. Nonetheless, I think it's a useful framework. We should seek to anchor ourselves through Enlightened Investors (Buddha), a valid Investing Philosophy (Dharma), and an Investing Community (Sangha).
Enlightened Investors
Value-oriented investors generally view Benjamin Graham,Warren Buffett and Charlie Munger as the Holy Trinity of sorts of value investing. These three are considered the greats partially because of their status as pioneers and successful exponents, and partially because they have been so generous in sharing their philosophy with others. Luminaries such as T. Rowe Price have left a much smaller footprint on which to base one's learning.
The extent to which this Holy Trinity has influenced investors is easily seen. One of the books I read was Guy Spier's "The Education of a Value Investor". He recounts how he found himself asking "What would Warren Buffett do in my shoes?" The motivational speaker Tony Robbins calls this "modeling" our heroes. While Spier may seem extreme, going so far as to install a bronze bust of Charlier Munger in his office, he remarks how Winston Churchill's office at Chartwell was similarly decorated with reminders of people he admired, such as Napoleon, Admiral Nelson and Jan Smuts. The practice served Spier well in the 2008 financial crisis, as he studied "heroes of mine who had successfully handled adversity, then [imagined] that they were by my side so that I could model their attitudes and behavior." Naturally, we may have to reach into the past to find these true masters. The ever witty Charlie Munger notes that mimicking successful people works equally well "if you go through life making friends with the eminent dead who had the right ideas."
Investing Philosophy
I wrote an initial post about Buffett a few weeks ago outlining his philosophy as seen through the lens of his investor letters. I highly recommend Spier's book for more on his understanding of a value philosophy. Similarly, two of the other books I read, Mohnish Pabrai's "The Dhandho Investor" and Fred Martin's "Benjamin Graham and the Power of Growth Stocks", offer fresh perspectives on the Graham-Buffett-Munger investing style. Reflecting his debt to others, Pabrai says, "I have very few original ideas. Virtually everything has been lifted from somewhere." This is, however, extremely modest of him. While the philosophy may not be new, he comes up with inventive ways to view the challenge of investing, showing that there are different ways to express a broad philosophy.
Investing Community
Spier is by far the most explicit about the importance of developing an appropriate investing community. He states "we have to be extraordinarily careful to choose the right environment - to work with, and even socialize with, the right people. Ideally, we should stick close to people who are better than us so that we can become more like them." He believes that "creating the right environment or network helps tilt the playing subtly the right direction so that you become far more likely to succeed."
He also goes on to cite several quotes from Buffett emphasizing this principle:
- "The key to life is figuring out who to be the batboy for."
- "Hang out with people better than you, and you cannot help but improve."
- "Nothing, nothing at all, matters as much as bringing the right people into your life. They will teach you everything you need to know."
While this is a useful framework, I have some reservations. For example, which comes first, the Enlightened Investor or the Investment Philosophy? In other words, do we consider an investor Enlightened because we agree with his philosophy? Or do we start first with the Investor, and then trust in the investing lessons he imparts? It may be a case of "when the student is ready, the teacher will appear", to quote Spier. But I'm inclined to believe that the philosophy comes first.
It's also important to note that while we may look to Enlightened Investors as models, our styles will ultimately differ due to our inherent abilities and temperament. Spier recognizes this: "As investors, we all have shortcomings; as I came to see it, the key is to accept who we are, understand our differences and limitations, and figure out ways to work around them." He believes Buffett's "strength comes in part from this rock-solid sense of who he really is and how he wants to live." "Instead of trying to compete with Buffett, I should focus on the real opportunity, which is to become the best version of Guy Spier that I can be." This is something I can empathize with. Early in my career, I was often overwhelmed by the breadth of knowledge my various PMs had. Seeking to mimic them accentuated my natural tendency to be a dilettante ("[fluttering] all ways, and [flying] in none", to quote Philip Wakem in George Eliot's "The Mill On The Floss"). I have had to consciously accept that it is better to develop smaller pockets of knowledge, and to grow the number of these pockets over time.
Philosophy?
Finding the jewel of a valid investment philosophy isn't always straightforward. I was struck by how Pabrai's ethos of "Few Bets, Big Bets, Infrequent Bets" differs from much of academic finance, which generally preaches diversification and often seeks to reap small, frequent premia. This is complicated by the fact that there are many variations to a broad philosophy. Pabrai seems willing to bet on much more cyclical and leveraged businesses than most Buffett adherents. Even more unusually, Fred Martin's book positions Graham as a growth investor rather than a traditional value investor, relying on Graham's 1962 edition of Security Analysis, which, for whatever reason, appears to be have fallen out of favour with the value camp.
Deciding on a valid philosophy is a big part of the journey. However, we must be wary of letting a philosophy ossify into dogma. As Spier notes "part of what makes Warren himself so successful is that he's never stopped seeking to improve himself and that he continues to be a learning machine."
Community?
Identifying a community of like-minded investors is clearly an important part of the Three Jewels. However, as noted above, the group's philosophy can become rigid. Herding is also a genuine problem. Sometimes the group's beliefs can have little to do with the group's core philosophy (in several earlier posts - here and here - I've puzzled over why value investors routinely seem to be Fed-bashers). Avoiding herding is particularly important in investing. As Pabrai notes, "value investing is fundamentally contrarian in nature", so it would be antithetical to fall in line with groupthink. Referring to his contemporary Walter Schloss, Buffett wryly noted, "I don't seem to have very much influence on Walter. That's one of his strengths: no one has much influence on him."
Another issue is becoming resistant to sources of truth external to our chosen community. Wisdom and knowledge appear in the oddest places, and true learners are open to these opportunities. Investor Sanjay Bakshi recalls how he ignored the investment advice of a high school dropout, but later realized the man was an outstanding investor. In a more humourous riff on this (but no less important to Manchester United fans!), former manager Sir Alex Ferguson recently revealed that he signed club legend Eric Cantona after hearing his players Gary Pallister and Steve Bruce rave about the challenge of facing Cantona. Nothing exceptional about that, you might say - except for the location of the conversation. "I was in the bath with the players, which was highly unusual for me." A generation of Manchester United fans can be grateful for Ferguson's attention to sources of truth, even when in the bath!
The One Perfect Religion
The concerns I've raised apply to any pursuit of truth - investing, politics, or religion. I am reminded of the words of poet Elizabeth Alexander:
We crave radiance in this austere world,
light in the spiritual darkness.
Learning is the one perfect religion,
its path correct, narrow, certain, straight.
The Three Jewels of Investing are a useful starting framework. But no framework is perfect. The only answer is to continue learning (as the greats do), and to surround oneself with people who are intellectually curious and honest. My guess is that this is the key to improved investment results, but more importantly, continued intellectual growth.
(1) "Going for Refuge to the Buddha means seeing him as your ultimate teacher and spiritual example. It also means committing yourself to achieving Buddhahood...which means that you aim to become someone who sees the nature of reality absolutely clearly, just as it is, and lives fully and naturally in accordance with that vision."
(2) "The Dharma primarily means the teachings of the Buddha, or the truth he understood. The word 'Dharma' has many meanings but most importantly it means the unmediated Truth (as experienced by the Enlightened mind)... Regarding the Dharma as a refuge means seeing these teachings as the best guide to reality, and committing yourself to practicing them."
(3) "If we are to practice the Dharma we need the example and teaching of others who have done so before us, especially those who have gained insight into the nature of reality themselves. So the third of the Three Jewels is the Sangha or the spiritual community... We need the guidance of personal teachers who are further along the path than we are, and the support and friendship of other practitioners."
I have recently completed a slew of value investing-oriented books, and have been thinking about whether we can formulate a similar Three Jewels of Investing. You'll note that the title of this post is a question, rather than a statement. It would be immense hubris to pretend that I had uncovered something on the order of importance of the original Three Jewels. Nonetheless, I think it's a useful framework. We should seek to anchor ourselves through Enlightened Investors (Buddha), a valid Investing Philosophy (Dharma), and an Investing Community (Sangha).
Enlightened Investors
Value-oriented investors generally view Benjamin Graham,Warren Buffett and Charlie Munger as the Holy Trinity of sorts of value investing. These three are considered the greats partially because of their status as pioneers and successful exponents, and partially because they have been so generous in sharing their philosophy with others. Luminaries such as T. Rowe Price have left a much smaller footprint on which to base one's learning.
The extent to which this Holy Trinity has influenced investors is easily seen. One of the books I read was Guy Spier's "The Education of a Value Investor". He recounts how he found himself asking "What would Warren Buffett do in my shoes?" The motivational speaker Tony Robbins calls this "modeling" our heroes. While Spier may seem extreme, going so far as to install a bronze bust of Charlier Munger in his office, he remarks how Winston Churchill's office at Chartwell was similarly decorated with reminders of people he admired, such as Napoleon, Admiral Nelson and Jan Smuts. The practice served Spier well in the 2008 financial crisis, as he studied "heroes of mine who had successfully handled adversity, then [imagined] that they were by my side so that I could model their attitudes and behavior." Naturally, we may have to reach into the past to find these true masters. The ever witty Charlie Munger notes that mimicking successful people works equally well "if you go through life making friends with the eminent dead who had the right ideas."
Investing Philosophy
I wrote an initial post about Buffett a few weeks ago outlining his philosophy as seen through the lens of his investor letters. I highly recommend Spier's book for more on his understanding of a value philosophy. Similarly, two of the other books I read, Mohnish Pabrai's "The Dhandho Investor" and Fred Martin's "Benjamin Graham and the Power of Growth Stocks", offer fresh perspectives on the Graham-Buffett-Munger investing style. Reflecting his debt to others, Pabrai says, "I have very few original ideas. Virtually everything has been lifted from somewhere." This is, however, extremely modest of him. While the philosophy may not be new, he comes up with inventive ways to view the challenge of investing, showing that there are different ways to express a broad philosophy.
Investing Community
Spier is by far the most explicit about the importance of developing an appropriate investing community. He states "we have to be extraordinarily careful to choose the right environment - to work with, and even socialize with, the right people. Ideally, we should stick close to people who are better than us so that we can become more like them." He believes that "creating the right environment or network helps tilt the playing subtly the right direction so that you become far more likely to succeed."
He also goes on to cite several quotes from Buffett emphasizing this principle:
- "The key to life is figuring out who to be the batboy for."
- "Hang out with people better than you, and you cannot help but improve."
- "Nothing, nothing at all, matters as much as bringing the right people into your life. They will teach you everything you need to know."
Finally, Spier is fulsome in his praise of his friend Pabrai, and it is apparent that they have both reaped the benefits of an investing community.
But It's Not All Perfect
It's also important to note that while we may look to Enlightened Investors as models, our styles will ultimately differ due to our inherent abilities and temperament. Spier recognizes this: "As investors, we all have shortcomings; as I came to see it, the key is to accept who we are, understand our differences and limitations, and figure out ways to work around them." He believes Buffett's "strength comes in part from this rock-solid sense of who he really is and how he wants to live." "Instead of trying to compete with Buffett, I should focus on the real opportunity, which is to become the best version of Guy Spier that I can be." This is something I can empathize with. Early in my career, I was often overwhelmed by the breadth of knowledge my various PMs had. Seeking to mimic them accentuated my natural tendency to be a dilettante ("[fluttering] all ways, and [flying] in none", to quote Philip Wakem in George Eliot's "The Mill On The Floss"). I have had to consciously accept that it is better to develop smaller pockets of knowledge, and to grow the number of these pockets over time.
Philosophy?
Finding the jewel of a valid investment philosophy isn't always straightforward. I was struck by how Pabrai's ethos of "Few Bets, Big Bets, Infrequent Bets" differs from much of academic finance, which generally preaches diversification and often seeks to reap small, frequent premia. This is complicated by the fact that there are many variations to a broad philosophy. Pabrai seems willing to bet on much more cyclical and leveraged businesses than most Buffett adherents. Even more unusually, Fred Martin's book positions Graham as a growth investor rather than a traditional value investor, relying on Graham's 1962 edition of Security Analysis, which, for whatever reason, appears to be have fallen out of favour with the value camp.
Community?
Identifying a community of like-minded investors is clearly an important part of the Three Jewels. However, as noted above, the group's philosophy can become rigid. Herding is also a genuine problem. Sometimes the group's beliefs can have little to do with the group's core philosophy (in several earlier posts - here and here - I've puzzled over why value investors routinely seem to be Fed-bashers). Avoiding herding is particularly important in investing. As Pabrai notes, "value investing is fundamentally contrarian in nature", so it would be antithetical to fall in line with groupthink. Referring to his contemporary Walter Schloss, Buffett wryly noted, "I don't seem to have very much influence on Walter. That's one of his strengths: no one has much influence on him."
Another issue is becoming resistant to sources of truth external to our chosen community. Wisdom and knowledge appear in the oddest places, and true learners are open to these opportunities. Investor Sanjay Bakshi recalls how he ignored the investment advice of a high school dropout, but later realized the man was an outstanding investor. In a more humourous riff on this (but no less important to Manchester United fans!), former manager Sir Alex Ferguson recently revealed that he signed club legend Eric Cantona after hearing his players Gary Pallister and Steve Bruce rave about the challenge of facing Cantona. Nothing exceptional about that, you might say - except for the location of the conversation. "I was in the bath with the players, which was highly unusual for me." A generation of Manchester United fans can be grateful for Ferguson's attention to sources of truth, even when in the bath!
The One Perfect Religion
The concerns I've raised apply to any pursuit of truth - investing, politics, or religion. I am reminded of the words of poet Elizabeth Alexander:
We crave radiance in this austere world,
light in the spiritual darkness.
Learning is the one perfect religion,
its path correct, narrow, certain, straight.
The Three Jewels of Investing are a useful starting framework. But no framework is perfect. The only answer is to continue learning (as the greats do), and to surround oneself with people who are intellectually curious and honest. My guess is that this is the key to improved investment results, but more importantly, continued intellectual growth.
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