WHY I DON’T CONSIDER OTHER PORTFOLIO’S PERFORMANCE IMPORTANT

 WHY I DON’T CONSIDER OTHER PORTFOLIO’S PERFORMANCE IMPORTANT

Being a professional money manager, you become, perhaps, one of the most analysed people there is. Attribution runs continuously while the markets are open; anyone within the firm can see, minute by minute, how you perform. You are acutely aware of where the pleasure and pain are coming from, stock by stock, point by point. That is not a healthy state, it encourages emotional reactions that are not consistent with cool, rational judgment and action, which are the hallmarks of successful investing. The point here is that too much information and too much looking and cause adverse outcomes.

The second point I want to make about professional management is that the reason for being and, in particular, mandates, are usually very narrowly defined. You pitch your skills with a particular bent, which is usually factor-focused. For instance, you are the best value manager or growth manager. The fund management industry has become a pigeon-holing process. That means you are expected to invest in a predictable way, your returns are measured against an appropriate benchmark and against comparable competitors. The analogy is a 100 metre race at the Olympics, where you know the distance, the venue, the competition and have some idea what time it takes to win.

Retail investors are nothing like that. The variation in all manner of inputs and outputs is extremely wide. These include risk tolerance, return expectations, experience, skill, level of wealth, wealth exposed (which is a subset of risk), etc. The approaches in retail land are just so wide that comparison becomes almost meaningless IMO, especially over the short to medium term. An acceptable measuring period used to be taken as 5 years, but that is based on the business cycle that hasn’t really existed since the GFC. So what is the appropriate time measure? Another question mark and another discussion.

To illustrate, take 5 scenarios for investors. One holds all TDs. Another holds 50/50 Td’s and an index fund. The next holds 100% in an index fund. The next owns a 100% index fund, financed 50% with debt and finally, the last owns a 100% debt-funded index fund. Under these assumptions, the returns will move in tandem with the broader market. The higher the market goes, the better the ending portfolios will do. Why? Because they are taking on more risk. Simple as that. The investor is making a very important but conscious decision to accept a certain level of risk and should accept the outcome. In this case, that is quite clear, but you may say that’s an asset allocation decision, it doesn’t apply to stocks. That’s where I disagree.

I contend that stock portfolios vary in risk, much in the same proportion as the above cash/stock portfolios. This will ruffle feathers because it questions the very being of investing and opens the issue of how returns are generated by luck, skill or risk. The inability to clearly delineate these issues is why I'm reluctant of too closely observe other portfolios. I will note the following from observing SM over the last few years, I suspect any broad-based investor site is similar. SM is most probably much better, skewing the results. When I look at others' portfolios, which I admit to not doing very often, and discuss further why below, what do I see? Usually, the best returning portfolios have one or two “flyers”. These are very often stocks I know nothing or very little about and have soared enormously. Fine, well done, but how does that help me? My conclusion is that it doesn’t. There are plenty of others on the site that have failed and probably left the platform. I don’t know the churn, but I expect a strong survivor bias. That’s the natural human condition. Here is the rub. When I look at the winners and losers, ex-ante, but being honest with myself and surprisingly to some, ex-post, I can't see a systematic winning formula. That is, is there an identifiable investment process that will continue to win over time? It looks like a lottery. My original plan was to write a piece called the Strawman Heretic, but maybe that’s too provocative. Lol.

There will be a winner of Powerball, I am sure of that; someone will win it. What I don’t know is the numbers to win, I don’t know when someone will win, and I don’t know how much they will win and I don’t know ex-ante who that is. Interestingly, few people search these winners out and ask for their numbers for the next draw. The reason is that most, but not all, accept the level of luck involved. My contention is that as we move out along the risk spectrum, with fewer parts of the jigsaw puzzle, luck plays a bigger and bigger role.

Where is this all going? When I left professional management, I pondered how to structure my portfolio, how much risk to take, given the usual constraints, but also how to be accountable and measure my performance. That was a big issue, and the answer came from what I thought was an unlikely source, C Munger. In hindsight, it was not that unlikely as a retail investor, I have found Munger much more useful than I found him as a professional investor, running those 100m sprints. Munger, simple, as usual, said, You should build an appropriate benchmark, make it hard, and measure yourself against that, ignore everything else. That’s exactly what I do and continue to do. Having said that, there are a few managers who are in my galaxy of style and risk, and I will periodically (very) view them to see if I am in the ballpark, but it is a very select few, and it is only a secondary check. Secondly, I will look for stock ideas, especially from people who have a similar style, and I think I understand what they are doing; this never stops and is a separate issue, imo.

The answer to why I don’t look at others' performance is multifaceted but it is not out of ignorance, fear, conceit, bias or anything like that. I just think others do things very differently, prepared to take different levels of risk, and some others I can't figure out what they are doing, luck can fool us into believing in shadows and looking too much is distracting and value destroying. Run your own race but still be accountable.