Letters to Our Clients
Most of us believe that experience in an occupation, measured by time spent on the job, leads to higher productivity for the employer and greater income for the employee. I agree that this belief holds true for most occupations. However, I disagree when it comes to the business of providing investment advice. In this business, the best experience is gained when an advisor’s own wealth is at risk, and his or her decisions are measured by personal dollars gained or lost. While it’s always good to be right about your investments and make money, the most valuable knowledge is gained through the experience of being wrong.
Our lives often seem to be dominated by numbers. Social Security numbers, drivers’ license numbers, account numbers… an unlimited number of 0’s and 1’s residing in thousands of databases, many of which are designed to keep track of our every move. Most of these numbers used to identify us are not necessarily wanted. However, there are some numbers that we do appreciate. Most are earned through hard work. Youngsters may take pride in their grade point average or SAT scores. For adults, numbers tend to be used to measure our individual accomplishments and disappointments.
“When the facts change, I change my mind. What do you do madam?”
- Winston Churchill, John Maynard Keynes, Paul Samuelson?
The CFA Institute’s second quarter 2017 Financial Analysts Journal included a research article penned by Martijn Cremers, professor of finance at the University of Notre Dame, entitled “Active Share and the Three Pillars of Active Management: Skill, Conviction, and Opportunity.”
We are currently struggling with portfolio construction due to historically high stock prices and interest rates that provide little reward, and I thought it would be beneficial to share with you Cremers’ understanding of what it takes to be a successful money manager:
The vast majority of businesses manage their operations according to a plan. That plan may be as simple as an entrepreneur writing down a few goals on a napkin, or as complex as a massive set of instructions covering the day to day, month to month, year by year, or decade by decade actions required to maximize profits. However complex the plan may be, it will guide the business’s use of its capital for future growth. This entire process is dependent upon the extremely difficult practice of forecasting.
Now that I am an honored member of the “gray-beard club” of investment managers, I can reminisce fondly back to the time when I first entered this business and began learning my trade with the utmost confidence of the “cute, fuzzy, teddy bear” youngster I was. I would like to share with you some thoughts of a few other “gray-beards,” but first I am going to share with you the story of “The Great Winfield” from Adam Smith’s The Money Game, first published in 1967. The story is a little long, but it is a very enjoyable and worthwhile read.
One of the greatest strengths of American capitalism is how it addresses the problems faced by its citizens. The greater the problem, and the more lives impacted by the problem, the more entrepreneurs, academics and government officials there are seeking solutions. As it is, government tends to attack problems with laws and regulations that they hope will then steer profit seeking entrepreneurs to find a solution benefiting all of society. In the world of investment management, these profit seeking entrepreneurs rely heavily on the work of academic researchers to isolate a process that can then be manufactured into a product and monetized.
Kendall J. Anderson, CFA