I have the pleasure of sitting next to Charles Hovenden, who has an excellent record of running absolute return products. Charles is a delightful colleague, engaging, thoughtful and entertaining in equal measure. However, towards the end of each month he becomes more withdrawn, anxious and well let's say just a bit crotchety.
2018 was not a good one for absolute return strategies and for many active managers in general, as markets became increasingly driven by momentum. This is not unusual in a mature bull market but nevertheless it makes it no less difficult to come to terms with. Clients rarely recognise such subtleties, elevating pressures as reporting periods approach and little wonder that portfolio manager tension builds towards the end of the month.
One of the problems with the investment discipline is that the feedback loops are so drawn out. Many of the active managers Square Mile rate make decisions based on time horizons extending across many months if not years. Assessing the success of these decisions over a month, quarter or single year makes little sense, and, there is plenty of evidence to suggest that success and failure cannot be determined over such time frames. However, this doesn't seem to stop people from trying.
Over the short term, a great deal of the investment outcome is outside the control of investors. Learning to cope with the emotional and rational aspects of this is not easy. I love to play strategy games, especially those that contain a probabilistic element to them and I have played poker (for modest stakes) for many years. Poker, unlike casino games, is played against other players and is a game of great skill. It is also a game of luck. In each game, players suffer or benefit from different degrees of luck, however, each player plays with their own level of skill. A lucky poor player may beat an unlucky skilful one but over time luck averages out and skill is rewarded. Further thoughts on this can be found in Michael Mauboussin's excellent book on the issue.
One of the beauties of poker is that feedback loops are measured in minutes rather than years and many hands are played in a single game. However, the large degree of luck involved in the game ensures that it may take many games for skill to be rewarded. Incidentally, it does not mean that skill cannot be recognised at the table, merely if you are measuring skill by successful results, a very large sample size is required. Understanding this and continually feeling an emotional response to what I know are random events has helped me become a stronger poker player. I believe that it has also helped me become a better investor.
Performance shortfalls over a month, quarter or year do not necessarily indicate poor decision making. My experience from playing poker has taught me that losing periods can persist far longer than you might think. Dealing with this emotionally is not easy. The reverse is also true. Arrogance and exuberance are equally as dangerous traits for poker players and investment managers. One of my favourite quips to junior analysts is that underperforming managers are probably not as bad as you think they are. And conversely, outperforming managers probably aren't as brilliant as you might believe. When it gets to that time of the month again, just don't worry about what you can't control.
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