Sunday, October 11, 2015

Investing is a Personal Journey

What do you want to do? What do you want to own? What is your approach? These seem like simple but are actually complicated questions. Although you and I can study the processes of great investors like Warren Buffett for example and even own some of the same securities, we cannot be Warren Buffett as we have to follow our own journey and live with the results. The investing world is outcome oriented, but to be successful over time an investor's decision making process must be personal, disciplined, adaptable and process oriented.

Michael Mauboussin illustrated this concept in a 2004 research paper where he categorized the process used to make decisions (in the probabilistic field of investing) and outcomes as; (a) good decision making process = deserved success or bad break; or (b) bad decision making process = dumb luck or poetic justice.(1)

To survive over the long-term, a successful investor's decision making process and overall approach must fall into category (a) which says bad breaks will come and go but deserved luck will eventually emerge over time. So if you have not done so already, you will need to develop a sound process, knowing that your short-term results will not be indicative of long-term results. Since you are completely responsible for your results over time you must take this to heart in your decision making process.

In an age of information overload, you must learn to source and process information effectively as well as focus only on what is truly meaningful. This is an acquired skill that is influenced by your investment process, background and personal circumstances.

Through experience as an individual investor that will include losses and setbacks you will have the  opportunity to figure out what advantages and disadvantages you have compared to professional investors on Wall Street. It is important to have this awareness or to develop this understanding. While individual circumstances vary, there are some advantages and disadvantages generally common to all individual investors which include but are not limited to:


1) Ability to enter or exit a position or market at your will assuming you have staying power with your capital. Professionals do not have this level of flexibility;
2) option to hold onto investments for the period of time you choose (minutes, hours, days, weeks, months, years and decades, etc.). Professionals do not have this flexibility due to the fund flows of their investors which they do not control, among other factors;
3) ability to not be focused on meeting or beating performance benchmarks in the near term or over time; 
4) flexibility to pursue a strategy that matches up with your strengths, weaknesses and circumstances. Professionals cannot do this as they must live within the constraints of their asset class and investment mandate; and
5) ability to self critique your process and performance in private along with the ability to avoid chasing performance.


1) In general, less skill and training;
2) less access to timely and quality information along with less knowledge about how to use it;
3) potentially higher information and transaction costs;
4) typically less access to company management teams, experts and centers of influence, among other factors; and
5) performance risk that exists due to lack of sound approach and quality decision making.

My recommendation is that as you develop, alter or refine your process-approach you take the above and other personal circumstantial issues into consideration. Doing so will increase the odds of  achieving better long term results. There is also a massive amount of information available on investment approach and process that I will highlight over time. Savvy consumption and application of this information is critical to long term success as investor. The journey is yours.

(1) Michael J. Mauboussin, "Decision-Making for Investors, Theory, Practice and Pitfalls," Legg Mason, Mauboussin on Strategy, May 24, 2004.

Saturday, October 3, 2015

Not Quite Peter Lynch and Neither is Your Expert

Earlier this week I had a chance to spend some time with an estimated 200 professional investors (pros) at an institutional investment conference.(1) The pros were there to listen to and engage in Q&A with the senior management from well known and widely followed companies in the gaming industry that included MGM, BYD and WYNN, among others. The pros represent the largest and most sophisticated institutions in the markets. The pros were mostly men without ties who updated company models-notes on their laptops while listening to the company executives speak about issues of the day within their companies and industry. This gathering was closed to the public and had the typical look and feel of similar events with the companies selling their scripted stories designed to put forth the message they want to tell the pros (i.e. the market). The pros in turn, listened for any hint of new information that might impact their company models and forward looking assumptions.

Company executives know the drill here as conferences like this occur year round with the pros. The pros (who know the drill as well) are a highly educated, talented and hardworking group of individuals who possess high level analytical skills were there as part of their ongoing effort to figure out the potential future value of these companies by focusing on any new information that might impact the value of company debt and equity. The pros know the detailed company stories, numbers and models far better than individual investors can imagine. Their collective model assumptions and opinions represent what is known as the "consensus" which drives stock and bond prices of these companies. In other words. the decisions and actions of this group act as a key price setting mechanism for debt and equity issued by the companies who presented this day.

If you do not understand this already, you need to understand the pros set the market price as you and I, as individual investors do not. The other thing you must understand is that this crowd is smarter than you and I. In other words "fuggedaboutit" if you think you can beat the pros (i.e. market) over time using less sophisticated thought processes, strategies and analytical techniques.

The relevant point here is that the majority of this talented group cannot beat the market despite industry expertise, access to the companies and the skill they possess. In August 1975 Charles Ellis wrote a now famous article for the "Financial Analysts Journal" titled "The Loser's Game."(2) In the introduction the article Ellis wrote the following:

"Gifted, determined, ambitious professionals have come into investment management in such large numbers during the past 30 years that it may no longer be feasible for any of them to profit from the errors of all the others sufficiently often and by sufficient magnitude to beat the market averages."

His point was that the professionals were not beating the market as the market was beating them. This remains true today as the overwhelming majority of active fund managers (i.e. the experts) do not beat the market despite their superb skill level. The question here today is that if the probability of the pros beating the market in any given year today is 10% or less and lower for consecutive years, what is the probability you can beat the market over time based on your skill level? The answer is near zero to zero. On this point Ellis argues that the premise professional money managers can beat the market is false. Ditto for the overwhelming majority of individual investors in spite of psychological resistance to this reality by some.

So one of the basic questions you the investor must answer is do you want your money to be actively or passively managed? In other words, if you and your professional guru(s) cannot beat the market, join it. If you do, the odds are that you will beat 90% or more of professional money managers as well as your own performance as an active investor.

The advantage of passive investing is low cost diversification compared to active management, among other factors. Passive investing has been around for a while and has taken off since the 2008 financial crises as most managers (i.e. experts) have not kept up with the market. Warren Buffett also recommends this approach. It is also worth noting that in this day and age, the related strategy of smart beta funds have emerged that have some combined characteristics of both passive and active investing but may impose higher fess than purely passive investment options. There are a number of sponsors that offer passive and smart beta instruments and lot's of information available today on these important topics. I include some sources below related to passive investing as a starting point.

Passive investing is an important strategy and one that deserves serious consideration. If this concept is new to you, I would start with Charles Ellis's book, "Winning The Loser's Game."(3) Even if it is not, I strongly recommend the book. I would also spend time on the Vanguard website and in John Bogle's writings on this subject as well as the "Wealthfront"(4) website.

I have been and remain both an active and passive investor. Peter Lynch of Fidelity beat the market for 11 out of his 13 years as an active professional investor and made Magellan one of the most successful funds in history. His record is near impossible to beat by most professional or individual investors.

(1) Deutsche Bank and UBS Gaming Investment Forum, September 28, 2015.
(2) Charles D. Ellis, "The Loser's Game," The Financial Analysts Journal, July/August 1975.
(3) Charles D. Ellis, "Winning the Loser's Game, Timeless Strategies for Successful Investing," Sixth Edition, July 9, 2013.