Monday, December 30th, 2013
every seven years

We are in the season of looking back and looking forward, prompted by the turning of a new year that reminds us of the relentless passage of time.

In many ways, one year doesn’t tell us very much, although you will soon be reading lots of stories about the best asset classes and the best managers of 2013.  In isolation, that information will have little value and may prove to be counterproductive, but it will be hard to resist the pull of recent success.

In the context of history and its patterns, the results might tell you more.  So, how many years do you need for the evidence to become meaningful?  There are statistical answers to that questionthe research puzzle | Which are often ignored, as this piece on the Sharpe ratio indicates. — or you can observe industry practices (including the apparently magical flip of a switch when a track record reaches three years) — but no precise answers are available.

Of late, I have been thinking in seven-year periods.  You might attribute that to the increasingly famous projections of seven-year real returns put out by GMOresearch puzzle pieces | This is from June.  The forecasts have continued to deteriorate. or to seeing The Seven-Year Itch, the movie (from a play) that spawned psychological theories about personal relationships and the waxing and waning of human interest in almost everything.

Instead, my musings were molded over the last few months as I viewed all eight films of the Up series.Wikipedia | This crowd-sourced summary is quite good.  They follow the lives of fourteen children since 1964, with a new documentary appearing every seven years.  In the most recent one, which was released in 2012, they are 56 years old.

The films are fascinating in a number of ways.  For someone like me who is a year or two older than the subjects, there are reflections of my life in theirs, even though they grew up in Britain and I in a Minnesota town.  You see your own development in the stories and faces of others — the successes and the failures, the struggles and the joys, the continuities and the sudden twists of fate, and the battle between the wisdom and the weariness of age.

However, this is a blog about the investment world, so let’s get on with it.

It’s hard to believe that seven years ago stocks were many months from their peak and that the depths of the financial crisis wouldn’t come for another two years.  Seven years can encapsulate an amazing range of events.  You often hear asset managers, asset owners, and consultants talk about performance over “a complete market cycle.”  Despite its frequent use, the phrase resists definition (just try to pin someone down on it).  I’m starting to think that seven is a reasonable number of years for most evaluations.

But let’s not get hung up on that.  Watching the Up series reinforced my belief in several of my principles of investment evaluation:

*Longitudinal studies offer invaluable perspectives.  Surely, investors will respond to cumulative performance numbers for longer periods of time, but they will often miss the telltale patterns within those periods and, more importantly, will overlook the subjective evidence of organizational change that makes a performance record less likely to be repeated in the future.

*We perpetuate our views, whether warranted or not.  The original premise of the Up series was that at seven the young children would provide the evidence of the people that they would become.  (“Child is Father to the Man,” to quote a subsequent album title.Rolling Stone | Here is the 1968 Rolling Stone review of the often overlooked debut LP of Blood, Sweat, and Tears.)  As investors, we are champions at such framing.  Sometimes our expectations are right and sometimes they are wrong.

*The act of measuring can have an impact on what (or whom) is being measured.  (Somewhat like the Heisenberg uncertainty principle in physics.American Institute of Physics | This is a simple explanation of the principle (with lots of links).)  There’s no way to know, but I’d guess that the observation of the Up participants (and the attention that they have received) changed their choices.  A similar thing happens with money managers, sell-side analysts, etc.the research puzzle | See, for example, this 2012 piece about Apple.

*We make broad assumptions based upon a small slice of the relevant information.  This was a topic of discussion in 56 Up — that the filmmaker has built portraits of individuals with relatively few minutes of film out of more than five decades of life.  And the subjects will be remembered forever based upon those minutes.  Similarly, we often know very little about investment professionals and organizations and how they really work.  Based on a few snippets (the product of some careful work in the editing room), we reach our conclusions about them.

That is the philosophizing for now.  From me to you, a wish:  May your next seven years be great ones.