Tuesday, October 1st, 2013
this most difficult game

The last posting looked at some of the key insights found in The Paradox of Choice by Barry Schwartz.the research puzzle | The book was published in 2004.  I compared “satisficers” and “maximizers” to believers in passive management and active management, respectively, which struck a chord with a number of readers.

As promised at the end of that piece, this is the first of two more to follow that will continue to examine the implications that stem from the “dizzying selection” of investment products extant.  Today we will focus on what the environment means for the buyers and owners of those products; next up will be some recommendations for the creators, sellers, and managers of them.

The most basic question for those hiring investment managers and advisors is the one identified in the first posting:  Should you be a maximizer or a satisficer?  The former demands lots of work and considerable skill in selection, while the latter requires virtually no work and no skill, yet generally gets you average performance for short periods — and likely well above average results over most longer time horizons.  Isn’t that good enough?

For many it’s not.  The allure of beating the market overwhelms all other considerations.  Earlier this year, I talked to someone whose organization invests with fifty advisors, putting them in direct performance competition with each other (and, believe it or not, reallocating assets on that basis up to twice a month).  She eschews passive management, because “it’s never ahead; it’s always fourth or fifth.”  I didn’t want to argue the point, but something that’s “always fourth or fifth” (of fifty!) ends up winning in the end, as those temporarily ahead of it change places and lose the performance derby they are so desperately trying to win.research puzzle pieces | The performance patterns of portfolio managers are quite interesting, by the way.

To invest actively, whether directly in the markets or by selecting managers, your approach can’t be cavalier.  It needs to be grounded in defensible investment beliefs and applied in a disciplined fashion.  Do you have a philosophy, plan, and process that will deliver success?  Do you have the time, skill, and money to make it happen?  If so, proceed.

What will greet you next on your journey is a cacophony of facts and opinions put forth by investment organizations, the financial media, academia, bloggers, and numerous other players.  Most of it is simply noise, irrelevant to your quest, although much of it will enthrall you, making it hard to judge the inherent value of one idea versus another.

Performance numbers and rankings will seem to identify the best in show and will frame your decisions even when you don’t realize that they are doing so.  Statistics will be misused and misrepresented,the research puzzle | See this June posting on the Sharpe ratio. and outcomes will be put forth as skill when they are good and bad luck when they are not so good.  Prognostications will flow forth in abundance.

Asset owners (individual and institutional) and gatekeepers (consultants and advisorsFinancial Advisor | According to one study, advisors are subjected to “50 and 100 sales pitches per week.”) have the challenging task of sorting out the good from the bad (should the choice have been to take the active route to begin with).

Some suggestions:

Simplify.  Pick your spots.  You can’t know it all.  Concentrate on what matters and let the rest go.

Avoid the dangers of false precision in response to a noisy world.  Take everything — especially performance numbers — with a grain of salt.

Don’t get caught up in the fascinations of the market from day to day, but take advantage of them to judge how managers behave.  Not whether they end up being right or wrong, but what their approach to issues large and small says about how they do what they do.

Compare “how they do what they do” with their marketing messages and look for gaps and lapses.

Focus on process as much as possible.  Ask yourself how much you truly know about a manager that didn’t come directly or indirectly from the manager.

Speaking of process, re-imagine your due diligence efforts.  How can you surface information that’s different from the crowd’s?

I know that those suggestions sound like platitudes — they sound that way to me too — but if you analyze, hire, and fire investment managers, humor me by giving yourself a grade on each of those six suggestions.

Then consider if it’s time to sketch out a new approach to this most difficult game.