But being in the top 50% every year for ten years? That is not random. That is skill. That type of consistent solid management is what you should be looking for.
By the way, I mentioned earlier that past performance was statistically useful for ascertaining relative performance of certain types of funds like bond funds and international funds. In the fixed-income markets (bonds) everyone is dealing with the same instruments. Funds with lower overhead and skilled traders who aggressively watch their trading costs have an edge. That management skill shows up in consistently above-average relative returns.
Likewise, funds which do well in international investments tend to stay in the top brackets. That is because the skill set for international fund management is rare and the learning cost is high. In that world, local knowledge of the markets clearly adds value.
But in the US stock market, everybody knows everything everybody else does. Past performance is a very bad predictor of future results. If a fund does well in one year, it is possibly because it took some extra risks to do so and eventually those risks will bite the fund and its investors. Maybe it was lucky and had two of its biggest holdings really go through the roof. Finding those monster winners is a hard thing to do for several years in a row. Plus, the US stock market is very cyclical, so that what goes up one year or even longer in a bubble market will not do well the next.
Investors Behaving Badly
Gavin McQuill of the Financial Research Center sent me his rather brilliant $5,000 report called "Investors Behaving Badly." He was the author and he did a great job. I read it over one weekend, and refer to it again from time to time.
Earlier we looked at a report which showed that over the last decade investors chased the hot mutual funds. The higher the markets went, the less likely it was that they would buy and hold. Investors consistently bought high and sold low. Investors made significantly less than the average mutual fund did.
McQuill focused on six emotions that cause investors to make these mistakes. You should read these and see whether some of them are familiar.
1. "Fear of Regret: An inability to accept that you've made a wrong decision, which leads to holding onto losers too long or selling winners too soon." This is part of a whole cycle of denial, anxiety, and depression. As with any difficult situation, we first deny there is a problem, and then get anxious as the problem does not go away or gets worse. Then we go into depression because we didn't take action earlier, and hope that something will come along and rescue us from the situation.
2. "Myopic loss aversion (a.k.a. as 'short-sightedness') - A fear of losing money and the subsequent inability to withstand short-term events and maintain a long-term perspective." Basically, this means we attach too much importance to day-to-day events, rather than looking at the big picture. Behavioral psychologists have determined that the fear of loss is the most important emotional factor in investor behavior.
Like investors chasing the latest hot fund, a news story or a bad day in the market becomes enough for the investor to extrapolate the recent event as the new trend which will stretch far into the future. In reality, most events are unimportant, and have little effect on the overall economy.
3. "Cognitive dissonance - The inability to change your opinion after new evidence contradicts your baseline assumption." Dissonance, whether musical or emotional, is uncomfortable. It is often easier to ignore the event or fact producing the dissonance rather than deal with it. We tell ourselves it is not meaningful and go on our way. This is especially easy if our view is the accepted view. "Herd mentality" is a big force in the market.
4. "Overconfidence - People's tendency to overestimate their abilities relative to individuals possessing greater expertise." Professionals beat amateurs 99% of the time. The other 1% is luck. The famous Clint Eastwood line, "Do you feel lucky, punk? Well, do you?" comes to mind.
In sports, most of us know when we are outclassed. But as investors, we somehow think we can beat the pros, will always be in the top 10%, and any time we win it is because of our skills and good judgment. It is bad luck when we lose.
Commodity brokers know that the best customers are those who strike it rich in their first few trades. They are now convinced they possess the gift or the Holy Grail of trading systems. These are the people who will spend all their money trying to duplicate their initial success, in an effort to validate their obvious abilities. They also generate large commissions for their brokers.
5. "Anchoring - People's tendency to give too much credence to their most recent experience and to show reluctance to adjust their current beliefs." If you believe that NASDAQ stocks are the place to be, that becomes your anchor. No matter what new information comes your way, you are anchored in your belief. Your experience in 1999 shows you were right.
As Lord Keynes said so eloquently when forced to acknowledge a shift in a previous position he had taken, "Sir, the fact have changed, and when the facts change, I change. What do you do, sir?"
We expect the current trend to continue forever, and forget that all trends eventually regress to the mean. That is why investors still plunge into index funds, believing that stocks will go up over the long term. They think long term is two years. They do not understand that it will take years - maybe even a decade - for the process of reversion to the mean to complete its work.
6. "Representativeness - The tendency of people to see patterns within random events." Eric Frye did a great tongue-in-cheek article in The Daily Reckoning, a daily investment letter (www.dailyreckoning.com). He documented that each time Sports Illustrated used a model for the cover of their swimsuit issue who came from a new country that had never been represented on the cover before, the stock market of that country had always risen over a four-year period. This year, it is time to buy Argentinian stocks. Frye evidently did not do a correlation study on the size of the swimsuit against the eventual rise in the market. However, I am sure some statistician with more time on his hands than I do will brave that analysis.
Investors assume that items with a few similar traits are likely to be associated or identical, and start to see a pattern. McQuill gives us an example. Suzy is an English and environmental studies major. Most people, when asked if it is more likely that Suzy will become a librarian or work in the financial services industry, will choose librarian. They will be wrong. There are vastly more workers in the financial industry than there are librarians. Statistically, the probability is that she will work in the financial services industry, even though librarians are likely to be English majors.
South Africa, Laguna Beach, and Canada
South Africa is still on the top of my list of places I enjoy. Friday I spoke at a conference for 1,000 investment advisors at Sun City. Sun City is one of the most amazing conference facilities and hotel complexes I have ever been to. The vision to build this fabulous resort in the middle of the South African bush and then believe everyone would come is truly unique. The attention to detail on the art, decoration, landscaping, and the numerous entertainments is impressive. If you ever get the chance to come, you should take it. And let me take this time to thank partners Prieur du Plessis and Paul Stewart for being such good hosts, even if they do work me a little hard trying to get all the value from the time I am here.
At the end of the month, I will fly to Laguna Beach to spend a weekend at good friend Rob Arnott's annual thinkfest at Research Affiliates. That meeting is always one of the highlights of my year, both from the perspective of meeting old friends around great food and wine, and also for the sheer massive investment brainpower in the room. And in June I'll make a quick trip to Montreal to speak for Cannacord.
And I hope you enjoy your week.
Your hoping to see the Big Five game animals this afternoon analyst,
John Mauldin
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