Hi Guys,
Oftentimes, insights and understanding come at unexpected times from unlikely sources. Here is one such instance from my personal experiences.
Many years ago I was touring the Jack Daniels Distillery in Lynchburg, Tennessee. Frankly, I am a little partial to their No. 7 Tennessee whiskey. I visit the site and the product regularly. On my very first visit, their guide told us this story (I’ll paraphrase) when we commented on the slow pace of the workforce.
“This is typical of Jack Daniels and most other places I’ve worked. About 20% of the folks work diligently and produce about 80% of the output. That’s true here and most everywhere else in Tennessee.” Perhaps without knowing it, this observant guide introduced me to the Pareto Principle. It’s not really a Principle, but more like an accumulation of observations that seems to loosely define an input/output relationship.
The Pareto Principle is more commonly known as the 80/20 rule. Examples are that 20% of the input creates 80% of the outcomes; 20% of workers generate 80% of the product; and 20% of customers account for 80% of profits. Extrapolating this observation into the mutual fund industry, something like 20% of active fund managers generate 80% of the industry Excess Returns, Alpha.
There is an underappreciated imbalance between effort and results. Being energetic and constantly busy is not always the best rewarded course of action. Being action lazy, but thinking more deeply and slowly to identify a simpler action pattern can produce a better outcome. Currently, the superior returns, on average, generated by Index products over their active fund counterparties is an excellent illustration. However, that’s true only “on average”. Noteworthy exceptions are out there awaiting discovery. Persistence is a residual issue.
The universality of the 80/20 rule appears in many unexpected and disparate disciplines.
This realization brings to mind an old war story that addresses a rating matrix formulated by famous Prussian Field Marshal Helmuth von Moltke. He evaluated his officers and assigned them into a 2 by 2 matrix. One dimension of the matrix is brainpower, smart or dumb. The second dimension is activity level, energetic or lazy. The matrix interpretation goes as follows.
Those officers in the dumb and lazy box are ignored; they don’t matter. Those in the smart and energetic group are respectfully rewarded with field assignments but carefully monitored and controlled to limit their potentially negative impact. Those in the smart and lazy much smaller cohort are the most highly prized and are given critical staff planning positions. Of course, those in the dumb and energetic group are immediately dismissed since they can do real damage.
Here is a Link that more precisely defines General Moltke’s two dimensional rating system:
http://old-soldier-colonel.blogspot.com/2011/07/field-marshal-moltkes-four-types-of.htmlWhen applied to the hunt for superior active fund managers, this appraisal matrix suggests that we should be searching for active managers who trade less often and have a low turnover rate (lazy?). These characteristics contribute to a lower cost fund which all experts suggest is a step along the Alpha success (smart) route.
There are potential investment takeaways from many diverse fields of expertise if an investor is flexible and alert.
Just some of my not purely random thought experiments on an eventful market trading day. I did nothing today with respect to my portfolio.
As Warren Buffett noted: “It is not necessary to do extra ordinary things to get extra ordinary results.” That's a great insight from a likely source to complete this submittal circle.
Best Regards.
Comments
Ain't that the truth!