A cash cow for the wrong term

Nothing stokes the ire of an active fund manager more than the suggestion that a higher primate, throwing darts blindfolded at financial pages performs a more worthy investment purpose.

That was the claim nearly fifty years ago by Princeton University professor Burton Malkiel in his bestselling book, A Random Walk Down Wall Street, where he pejoratively wrote “A blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts.”

Some have even argued that Malkiel didn’t go far enough, noting that far from doing ‘just as well’, dart throwing chimps have done a much better job than both the experts and the market.

Norwegian’s up the ante on Malkiel’s blindfolded monkeys

And now the Norwegian’s are rubbing salt into the wounds. In 2016 Norway’s state broadcaster NRK ran a programme featuring a stock picking contest involving two stockbrokers, an astrologist, two beauty bloggers, and a small herd of cows (source: Financial Times).

Each team was given the equivalent of €1,000 to invest in Oslo-listed stocks for three months.

A cow named Gullros and her fellow ‘stock-pickers’ were led to a field where the producers had laid out a grid with the tickers for each of the 25 members of Norway’s OBX index. The cows picked their stocks by relieving themselves on the grass.

You could probably write the conclusion to this without reading on.

The professional stock pickers did manage to beat Cowpat Capital, but only by a fraction; +7.28% versus 7.26%. The overall winners were the bloggers, who at the start seemed bewildered, admitting that they did not recognise any of the companies that make up the index – arguably a reasonable proxy for the aforementioned blindfolded chimps.

The purpose of the programme was to show that markets are difficult to beat. And it is often hard to determine whether those that do manage it, owe it to skill or luck. I’ve dished out my fair share of criticism to active managers over the last decade and the temptation here is to pour further scorn on the dark art of stock picking. But I’m drawn to a different conclusion.

A 3-month time period raises serious questions

The programme was obviously a gimmick, and with the time period chosen - three months - quirky results were all but guaranteed. It would be no less peculiar than the result you might expect from an amateur pitted against Rory McIlroy in a one-hole putting competition. McIlroys’s chances are better than most of course, but a single stroke increases the odds of a fluke outcome. You’d hardly draw the conclusion that McIlroy is a charlatan if an amateur holed the putt and he didn’t.

Yet that is the conclusion we are being fed from the Norwegian programme. We can be quick to judge, without consideration of the context. I have found this to be a persistent fallacy of investing; that results over short time horizons offer some meaningful insight and worse, should influence investment decision making.

The most serious problem in the investment world is not necessarily short-termism, though a lot of value has been destroyed by investors myopia. But short-termism suggests a simple antidote; to be long term-oriented. But this advice is way too simplistic – every prospective investor I have ever met is long term oriented, until they write the cheque. So short-termism fits the experience of many investors. But as a theory about how financial markets works it is too nebulous to be much use.

It’s a case of investor ‘wrong-termism’

The proper diagnosis of our willingness to ascribe too much significance to short term events I think is more ‘wrong-termism’. Long term in name, but short term in practice.

Remember, the long term is just a series of short terms that need to be managed. As Morgan Housel says, “Every past decline looks like an opportunity, but future declines look like risk”. It’s dangerous to assume that because you have a long-time horizon you can ignore what happens in short run.  

A wrong-term investor in the US stock market with a 20-year time horizon, who was unprepared for 20% losses, has had five occasions in the last twenty years to abort their plans. I doubt they’d have stuck around to witness the second bear cycle, never mind the 5th. With all of the unrestricted access to financial market data these days, there’s no excuse for being unprepared.    

There was a twist to the Norwegian television programme. The presenters revealed that their own portfolio had gained almost 24 per cent – by far the best performing portfolio. But only because they had entered 20 different combinations, and ditched all the worst performers. This was to illustrate a concept known as “survivorship bias”.

This is a topic for a separate article all together. But it does serve to remind us that alongside trying to prepare for the market’s short-term gyrations, you’ll need a finely tuned rubbish radar that flashes red when claims of abnormal returns are made.

Be long term. Be prepared.  And be sceptical. Or you can make easy things difficult by prioritising the opposite.