I must have missed this earlier in the month, but Mauboussin gave an interview in which he said a lot of smart stuff. I won’t do the piece injustice by throwing my own opinions on top so here are some snippets and the link.
You mentioned there could be pockets where active investing could do well. What pockets would that be?
There have been some classic studies. One case that continues to be true in the US is spinoffs. Large corporations have multiple businesses and when they decide to spin off a troublesome business, it becomes almost an orphan that no one wants to own. It turns out, buying those spinoffs has been a very lucrative strategy. Buying stocks where expectations are quite low is a good strategy because that is when valuations are cheap. We have data now for 90 years that shows value investing tends to work quite well. So the simplest way to say it is to repeat a Warren Buffett quote: “Be fearful when others are greedy and greedy when others are fearful.”
You have mentioned the ill effects of the recency bias — how do you stay clear of this?
There is a powerful concept that I opened the book Think Twice with, which was developed by economist Amos Tversky 40 years ago — the inside versus outside view. The idea is that when most of us face problems, the natural way is to gather information about it, combine your own inputs and project into the future. So naturally, what has happened recently often tends to be a large component of that. In contrast, the outside view is viewing your problem as an instance of a larger reference class, which is to ask the question what happened when other people were in this situation. One of the main ways to offset recency bias is to consider a larger sample set and a larger reference class and ask what you should expect. For example, I asked a friend, who is a baseball executive, who his favourite professional team is. His reply: often, if a player is playing particularly well, people start saying that this guy is more valuable than he really is. Whereas, if you step back and say what is right or wrong with his long history, what are other players like and how have they done, that is a far better indicator of his true underlying skill. So the inside-outside view helps meaningfully address the recency bias. But you have to be very explicit about it. It is not easy to do.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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