Hi Guys,
From the writings of Michael Mauboussin: "We have no control over outcomes, but we can control the process. Of course, outcomes matter, but by focusing our attention on process, we maximize our chances of good outcomes."
A few days ago a rather new MFO participant asked a question that inspired respectably wide and divergent replies, and attracted an even wider viewership. This was somewhat puzzling given the manner by which the subject was introduced: “Why Did Each and Every One of my Funds Beat the Index?”.
Please note that the main thrust of my post is not to be critical of the original poster, but to expand the discussion horizon of the topic. The originating post is merely a point of departure.
The MFO member asserted that all his mutual funds had outdistanced benchmarks for a 15 year period. Although that’s a highly unlikely event, probabilities do not go to zero given the huge number of accessible funds and the even larger number of mutual fund owners with unlimited portfolio construction options. So the claim can not be summarily dismissed.
To paraphrase one of the questions, the new member asked the MFO board to provide some explanations or suggestions for his success story. Stripped of its specific nuances, this is the old is it skill or is it luck conundrum?
By the very way the question was asked, the answer is embedded in the question itself. The new MFO member is baffled by his success. He requested explanatory aid. He identified no methodology in his sorting or selection process. In fact, that process likely morphed over time as the investor acquired some experience. Given these conditions, the most promising guesstimate is that the investor was purely a luck beneficiary.
That’s not a particularly devastating assessment. All investors, at one time or another, have experienced both winning and losing streaks. Since forecasting is an inexact discipline, luck must be an integral part of any outcome equation. But certainly all investors are not equal. The experienced, the informed, the patient, the persistent, the confident, the wealthy investor tilts the odds of winning just a little more in his direction. However, none of this is a rock solid guarantee for excess profits.
Even such an honored and heroic market wizard like Benjamin Graham recognized and adjusted to the changing dynamics of an evolving marketplace. Here is an extended quote from Graham that he enunciated late in his exceptional career:
"I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent, I'm on the side of the "efficient market" school of thought now generally accepted by the professors."
Graham modified and documented his thinking on this matter many decades ago. Given the proliferation of financial data, the ease of Internet research, and the overall enhanced knowledge, training, and smartness of present institutional investors, finding undervalued prospects today is a more daunting task.
The referenced contributor apparently used relatively unsophisticated, transitory, and sometimes flawed processes when sorting his way through the mutual fund selection maze. I do not wish to unnecessarily pile-on since many wise and informed MFO participants have already identified these shortcomings in his analysis, but several observations are worth repeating for emphasis and to establish my position on the matter.
Proper benchmark matching is really necessary to score the effectiveness of any investment decision. In general, that rule is violated time and time again. The assertion was for the recent 15-year period. That’s fine except how sensitive are the results to other timeframes? How does any portfolio compare for 5-year, 10-year, and 20-year time periods? An investor should always explore the robustness of his findings against a variety of timeframes.
Most importantly, the decision making process was totally ignored. The discussion merely centered on outcomes, the final score. I believe since future outcomes are unknowable, the process itself should be the focus of attention. As an investor, you control process, you never control outcomes.
That’s why I initiated my post with the Michael Mauboussin quote. You are free to alter the process if the circumstances demand a change; but the decision is always in your wheelhouse. You control process, and you should dutifully document any changes.
I congratulate any investor who assembles a portfolio that outdistances a meaningful, accurate benchmark. I find it amazing that a rather inexperienced investor can select individual portfolio components that each generate excess returns over their respective appropriate benchmarks. Although the odds are decisively against that happening, it does happen. More power to that rare bird. As the song goes “luck be a lady tonight”.
Rather than seeking explanatory help from the general investing population, if I were such an individual, I would be proclaiming the virtues of my methodology, my process. Now that’s the ultimate test. Is the process real and repeatable? Even scientists have been known to distort or falsify data to secure fame or fortune. Sad but true.
Folks tend to focus on successful investors, and often attempt to duplicate their success using similar methods. Frequently, that does not work because luck was a major factor in the outcome. It might be a more rewarding project to examine failures. We can learn far more from a failure analysis than from an ill-defined and morphing set of selection rules. The Space Program Challenger disaster was not fully examined until after the O-ring failure although accumulating evidence had suggested the O-ring sensitivity to low temperature.
I like Michael Mauboussin’s perspectives on investing. Here is a Link to a 36 minute interview conducted with him by the Motley Fool organization:
http://www.fool.com/investing/general/2014/03/01/an-interview-with-behavioral-investing-expert-mich.aspxI hope you enjoy and learn from this probing interchange.
It’s always friendly to offer a little lagniappe (a small gift) after such a lengthy posting. Since luck is an integral part of this posting, perhaps a few thoughts are appropriate.
Under certain circumstances luck is indeed arbitrary and uncontrollable, like being a victim in an earthquake. However, researchers believe that under a large number of circumstances, luck is somewhat controllable and can be improved. Situational awareness, a positive attitude, faith, perseverance, a relaxed personality, an openness to opportunities are several positive luck factors. It’s a complex phenomenon. There are several very popular Luck Factor books available. Here is a Link to a video interview with one renown researcher in this controversial field, Professor Richard Wiseman:
That’s my special lagniappe to you. Wiseman is a very entertaining and engaging fellow; he is also a talented magician. He offers several entertaining oddity-focused presentations on the Internet.
Sorry that I did not participate in the first posting exchange. I just returned from a cruise and needed some catch-up time. Besides, the MFO members who did join the fray did a wonderful and helpful job at uncovering and explaining the salient issues. A hardy attaboy to all; there were many nice, effective contributions. The originating poster showed courage in defending his positions. He too warrants an attaboy.
Also, I really wanted to expand the scope of these original exchanges into the Process and Luck fields.
Best Regards.
