Roger Ibbotson is a Professor in the Practice Emeritus of Finance at the Yale School of Management. He co-wrote Stocks, Bonds, Bills, and Inflation with Rex Sinquefield. This work is updated annually, and even if you have not seen the entire work, you have probably seen a chart or two showing the long-term performance of the stock and bond markets. Even we here at Anderson Griggs had the chart mounted on the wall for all to see at one time or another over the years. It is a standard reference for information and capital market returns.
Rob Arnott is the founder and chairman of Research Affiliates. He has written over 100 articles published in the Journal of Portfolio Management, the Harvard Business Review, and the Financial Analysts Journal, where he also served as editor in chief from 2002 through 2006. He is also the co-author of The Fundamental Index: A Better Way to Invest. You can thank Mr. Arnott for his major contribution to the ongoing discussion of using a smart beta approach to investing in order to outperform the standard indices such as the S&P 500.
At the conference, the subject of Ibbotson and Arnott’s debate was “Can the Markets be Timed?” What an interesting topic for two individuals who have both made a living through academic studies of the markets’ histories. When asked how to produce superior returns in the future Ibbotson said, “The stocks that are the most popular will do the worst.” He also said, “Go after the unpopular ones, tremendous amounts of money can be generated by taking some risk. I’m not suggesting you go in and out of the market, I’m suggesting you stay there.”
Arnott added, “Market timing, loosely defined, is not difficult. You just have to find the flows and do the opposite.” He added, “You have to remember that getting investors to sell what’s doing well and buy whatever is savage to them doesn’t come easily. Picking tops and bottoms through averaging is not hard. Averaging out of an expensive market is easy.”
Of course, I agree with both comments. We are usually only offered a company’s stock at a low price when the company is experiencing a problem, and because of that, most of us want nothing to do with the company. However, profitable investment rewards can be gained by finding companies that the crowd has passed up, identifying what factors lead to their being cast aside, and then having the resolve to buy those you believe will mend their woes and improve their businesses in the future.
Despite this, why is it that the majority of investors only choose to invest their hard earned savings into mutual funds whose recent performance is better than other mutual funds? Why is it that people are willing to believe that because some academic study showed that an approach to select securities worked historically, it will work in the future and produce the same or better returns?
If past performance is of little or no value, what is? The answer, I am sorry to say, is not quantitative in nature. The quantitative basics can be learned through education and experience. These include knowledge of investment techniques, security analysis, and proper portfolio construction. However, unlocking true value above and beyond those quantitative basics is more a result of the manager or management firm’s culture, investment philosophy, discipline, and integrity when faced with a never-ending line of naysayers. As the future unfolds and Justin gains more control of the business (I am not leaving anytime soon) I have encouraged him to keep the following characteristics in mind:
- Independence: A portfolio manager has to have the ability and the freedom to evaluate all available information and build a portfolio that is contrarian to current views and not be pressured to follow the crowd.
- Decision making: If a manager is required to take every non-consensus idea to a committee for review and permission to act, fewer rewarding ideas will be acted on.
- Flexibility: A manager must have the freedom to change when things change. He or she must be willing to recognize a past decision was wrong and take corrective action.
- Love of the business: The financial rewards for portfolio management are pretty good, yet the great managers are so passionate about investing that if they could survive, they just might work for free.
- Competitiveness: A great manager tends to be very competitive in their profession. They want to be the best they can be.
Kendall J. Anderson, CFA