Tuesday, September 23rd, 2014
decaying beliefs

In 2012, Samuel Arbesman wrote The Half-life of Facts: Why Everything We Know Has an Expiration Date.  I must confess that I have not read the book.  My awareness of it comes from a review by Shane Parrish on his excellent blog, Farnam Street.Farnam Street | Jason Zweig called it “a compelling blog about decision making.”  Agreed.

We know of the half-life of radioactive materials.  But there’s also a disintegration of accepted knowledge across disciplines; it’s just not very predictable.  In certain fields (math is mentioned by Arbesman), the body of knowledge changes pretty slowly.  In others, much more quickly.

He wrote that “the social sciences have a much faster rate of decay than the physical sciences.”  And, despite the attempts to turn finance into physics, you can’t get more social than the markets.

What is the half-life of an investment theme?  Of an investment theory?  Of an investment belief?  Their lengths are dependent on the economic actors who recognize, characterize, capitalize, organize, sensationalize, fantasize, and, ultimately, marginalize the concepts that are in play.

Granted, there aren’t many universal truths when it comes to markets.  There are lots of players and lots of opinions — and always some contrarians around.  But there are certainly dominant beliefs that drive the pricing of securities and the behavior of markets.  Gauging how sustainable those beliefs are, what will cause them to change, and how quickly they might change is a very valuable and elusive skill.  Judging the rate and timing of decay (if there is any decay — the belief might actually build further!) is damn difficult.

On the level of an individual security, beliefs can change abruptly.  Take, for example, the last quarterly release from Amazon.  In two years it may be forgotten — or it may be viewed as the time at which opinion changed.  There was nothing much different about it from the reports that preceded it, except that the dominant narrative (of a company building an unassailable moat that would someday be monetized) suddenly seemed to shift to the competing one (of a company that not only wouldn’t deliver on the bottom line, but couldn’tthe research puzzle | In which it would be a situation where “value flows from ino to customer, bypassing shareholders,” as discussed in this piece on “the nature of value.”).  If that is a lasting shift, Amazon’s price will perform differently even if operating results stay on the same course.

Or look at the BRICs.  Goldman Sachs put together that acronym in 2001 and, as the economic environment supported the thesis and asset owners and asset managers poured money in, the markets of Brazil, Russia, India, and China steamed ahead, validating and reinforcing the concept.  But it looks tattered now.research puzzle pix | This is a posting I did earlier in the year on a sister site (now on hiatus).  Where was that turning point?  What were the signs that the change was afoot?

Those kind of conceptual changes — regarding individual investment vehicles and themes/strategies — are the province of active managers and others trying to “play” the market in real time.  Other shifts happen more slowly.  Sometimes the tectonic plates are moving for quite awhile before the earthquake occurs.  Even if we notice a few signs along the way, it is the earthquake that gets our attention.  In other cases, it’s as if we awoke to a new world, even though we didn’t feel anything in our sleep.

Think of some of today’s building blocks in the investment ecosystem — the active/passive platforms (as currently defined), the asset class and style characterizations, the endowment model, the standardized and expected structures of asset management/gathering organizations, and on and on.  They didn’t exist before, but developed over time.  And, despite their current dominance, they aren’t forever; this is but a place on the road.

The same is true for the foundational theories (the efficient market hypothesis, modern portfolio theory, etc.).  They are not settled business, especially in an industry that’s very young and already radically changed from its state when the theories debuted.  Looking backward from the future, tomorrow’s investment professionals will see a body of knowledge that follows in some respect the graphic in the Farnam Street posting that charts the percentages of “studies with false or obsolete conclusions.”

Because of the decay across all of these levels, assessing the nature and pace of change should be a core competency of investment organizations, yet most aren’t structured or oriented to deal with the transformations in an organized way.

In addition, a profession of investment beliefs (a practice which I heartily endorsethe research puzzle | This is one of the pieces I have written.  Use the search box to find more.) can harden those beliefs and make you less able to see the decay of their worth as it occurs.

Also clouding the eyes are the ways that beliefs are marketed as truths, leading to a “truthiness” that appears valid until it doesn’t.  Many organizations set themselves up for eventual failure in that regard.

Even as you read this, the beliefs that you hold dear are decaying, eroding for a variety of reasons seen and unseen, just as the passage of time has worn away those that came before.  You should take notice before others do.