Special to the Globe and Mail
Published March 24, 2016
By Tom Bradley
Gillian Tett, a columnist with the Financial Times of London, wrote a piece three years ago that I tucked in my “Reread” file. I dusted it off this week.
The article referenced the late Pierre Bourdieu, a French intellectual who was of the view that it’s not just what we discuss in public that matters, but what we don’t discuss that’s really important in terms of reinforcing the status quo. He said, “Subtle cultural signals reproduce the position of the elite ...”
This is heavier stuff than I normally contemplate, but it relates well to my more mundane world of investment management. There are topics that keep repeating themselves – what Mr. Bourdieu calls the Universe of Discourse – that serve to entrench the industry’s social and political hierarchies, but do little to enhance investor returns. Indeed, they likely hurt returns.
Our current Universe of Discourse is heavily reliant on economists and their predictions, with the ones who have been most accurate recently having the loudest voices. There is no differentiation between skill and luck, nor is there accountability for previous forecasts.
The Discourse places importance and urgency on short-term events and returns, most of which are forgotten weeks or months later. There’s also a predisposition to provide simple explanations for complex events – a cause for every effect. The result is a pulsing desire to adjust our investments to what’s going on in the world. To take action.
To be successful, however, investors need to think beyond the established Discourse and focus on what’s important to them. The urgent news, short-term market moves and zigs and zags of the economy should be on the radar, but it’s the undiscussed and undisputed that has a more profound impact on investment returns, and needs to be deeply understood.
In my view, the following concepts don’t garner enough coverage.
Investing based on short-term strategies and forecasts is futile.
Outfoxing the market can work for a while, but doing it consistently is impossible. The world is complex and unpredictably interconnected, and too many variables are hidden in the shadows. And importantly, frequent trading doesn’t cash in on the biggest advantage most investors have – a long time horizon.
Time and risk are at the core of investing.
Time is required to unleash the power of compounding – Albert Einstein’s eighth wonder of the world. It allows investors to earn returns on their returns. At our firm, we often witness the wonder when long-standing clients are surprised by how much money they’ve made from earning high-single-digit annualized returns.
And time is inextricably linked to risk. For long-term investors who are well diversified, loss of capital is not an issue, nor is short-term volatility, although both feature prominently in today’s discourse. An investor’s true risk is the possibility of not achieving a reasonable long-term return.
Valuation is way more important than central bankers, politics and capital flows.
While investors watch the market’s every move and hang on economists’ every word, the best predictor of medium-term returns for bonds is the level of yields, and for stocks it’s price-to-earnings multiples. Admittedly, valuation measures are just as useless at predicting short-term market moves as dissecting the Federal Reserve’s meeting minutes or Donald Trump’s utterings, but they’re quite reliable when investors choose to look further out.
Rarely discussed is the fact that the interests of the wealth management industry are not the same as the clients.
Warren Buffett said it best: “Wall Street makes its money on activity. You make your money on inactivity.” Corporate growth strategies and compensation schedules are all about activity – new products, sales campaigns and strategy shifts. In the meantime, investors’ most effective option, most of the time, is ‘do nothing.’
And finally, emotion is the most consistent crippler of portfolio returns.
Yes, security selection and fees are important, but they pale in comparison to the impact that investor behaviour has. That’s because investing runs against human nature. We’re wired to buy high and sell low. As a result, changing direction at market extremes and/or abandoning the plan when it’s needed the most are all too common occurrences.
Investors need to develop a plan that takes an appropriate amount of risk, absorb the bumps along the way and take full advantage of a time horizon that is far beyond what the Universe of Discourse ever contemplates.