Facts Trap Us Into Choices - Weekly Blog # 526

by: Mike Lipper, CFA


Why do very bright people make wrong choices? In our highly professional world of investments why do so many financially sophisticated investors choose the wrong investments at the wrong time and in the wrong amount?

I believe that I should always be learning. Because of my investment performance background, I study smart investors who regularly make mistakes. Hopefully, I will learn to my clients and my own benefit. With the above mission in mind, I was struck by an article entitled "In Defense of Ignorance," which was published in the Marathon Global Investment Review. Marathon Asset Management is a very thoughtful and successful investment manager based in London.

Apparently, its skillset is to focus on the supply side of economic equations and limit its input largely to facts about supply. As this focused approach has worked for Marathon and its clients, I considered this thinking in terms of my own intellectual process of transitioning from security analyst through various stages to becoming an entrepreneur and registered investment advisor.

Career Transition

As I was finishing my active duty in the US Marine Corps, my plan of action to feed my young family of three (and more planned) was to become a security analyst, study all there was to know about a leading company in an important industry and be hired by a company's investor relations area as a person serving financial analysts. My career goal then was to be a junior officer of a large, stable, and hopefully growing company by retirement. Luckily, for me it didn't work out that way.

As an analyst my goal was to gather more facts than anyone else on a targeted company. Interestingly enough, the help of employers and analyst societies did not prepare me for the real commercial world. I had to learn, usually by observing, how to sell investment research, make sensible investment decisions, understand internal politics, seek clients, and learn how to run a business. Thus, I had to move away from the simple task of just gathering facts, as comfortable as that was, to a broader set of skills.

Analyst Vs. Entrepreneur

Recently, I have become convinced that much of the thinking processes of investment, business, and political leaders has evolved in a similar fashion. For a long time, leadership was assigned to those who gathered the most facts. Many of them were like a good litigating attorney that gathers all the known facts about a case. He or she does not want to be surprised by something said by a favorable or opposition witness.

After gathering the facts, attorneys are selective as to how they build their persuasive pitches. These types of leaders, often rising through highly structured organizations, are replaced or out-maneuvered by an executive decision-maker.

The rise of the executive decision-maker is changing our world as we know it. The old practice of following a case study of known procedures is giving way to more free-form decision-making. Increasingly, successful nations and business operators have less in common with their perceived competitors.

It is not this blog's mission to solve world and macro problems, but rather to focus on investments largely through investment managers and mutual funds. With that thought in mind, I am wondering whether our practice of building diversified portfolios based on asset classes, size of companies, locations, and market capitalizations, which worked well in the past, is becoming outmoded.

Should we assemble our managers and their funds as a good theatrical producer does with people of different talents? A good producer brings these multi-talented people together in a way that produces good results as a unit. As we move in that direction, we will need a different classification system, which may be different for each client portfolio.

The only time I had some limited experience with this was when I was fencing in college. In a very short time, I had to make a guess whether my opponent favored offense or defense, how to change the expected flow of events, how to lure an opponent into changing styles, etc. We know that most managers are reactive to prices or announcements, only some attempt to position prematurely.

Others march to their own drummer and stay fixed in their actions regardless of other stimulants. As we have very intelligent readership of these blogs, I am wondering whether any have some guidance for me as I struggle to adapt to my perceived view of the new world of investing.

For The Fact Gatherers

Demand for money is gradually rising. In the daily Wall Street Journal, there is a statistical box of ten "Consumer Rates and Returns to Investors." These indicators go from short term to 30-year mortgages. Each are shown at their current level and their range for the year. Four of the ten are near their annual highs and none are more than 51 basis points away from their annual high.

Two items:

  • Merrill Lynch's technical people view cyclicals as being more attractive than defensive stocks. They do not see a recession near term.
  • PIMCO's latest view is that the next economic recession is 3-5 years way.

When these two major market movers (along with most others) express their views, as a contrarian, I get worried about a surprise that blindsides the majority of the thinking. I would be particularly worried if the stock market goes to another new high this year.

There is likely going to be more excitement about the opening up of the Chinese "A" share market to foreigners. WisdomTree* is warning that many stocks do not have good characteristics as investments, so be careful.

*Personally owned.

All too often professionals utilize a formulaic process rather than adjusting to the changing environment. This leads in many cases to some bad choices.