“Regrets – I have had a few, but then again too few to mention…..” Happy the fund manager, policymaker, or retail investor who could, hand on heart, echo the sentiments of Frank Sinatra’s signature tune. They may do it their way, but it is rare indeed for that way to be free of regrets. More often, the regrets are too many, not too few, to mention.
It took me many years to realise the force of Charlie Munger’s observation that the aim of investment is to minimise regret, or (if you prefer) to minimise the opportunity cost of the decisions that you make. Acting in good faith is a necessary but sadly insufficient condition for achieving successful long term results. Quality of thinking, provided that includes retrospective analysis, and temperamental maturity matter much more.
Keeping the concept of minimising regret in mind can lead to some powerful changes in emphasis and approach. Just as corporations rarely spend much time analysing the outcome of their investment decisions, which condemns them to repeat them again in future, so professional investors are typically far more interested in analysing the next good thing at the expense of understanding why the last good thing turned out to be so disappointing.
Yet the latter approach will never be time wasted. The strength of the recent equity market rally provides a perfect example. Only those who had experienced or studied the way that previous bear markets end are likely to have avoided being caught out by the force of the recovery, which has sent emerging market equities up by 80% in some cases, and the S&P index by 50% from its March lows.
The process may still not be over, as there remains plenty of uninvested cash sitting on the sidelines in institutional and discretionary accounts. As the year end approaches, fund managers who have been left behind are suffering huge dollops of regret. The chances are however that unless they absorb the lessons of their failure to spot the change in market dynamics this time round, they will be condemned to make the same mistakes again in future.
For the retail investor, the paradox is that the regulators’ sensible (but largely futile) strictures against reliance on past performance may also have a downside, if the message obscures the fact that analysing past performance – especially disappointing past performance – is an essential prerequisite to doing better in future. It seems hard to believe how, if there was a readily accessible independent service that analysed the true cost of employing wealth managers, for example, many of those in the business could possibly survive.
A survey of 238 private banks and wealth management firms by Pricewaterhouse Coopers in the United States earlier this year found that around a third of those surveyed did not themselves believe that they were fully qualified to do the job. This may be a shocking finding, but it is not one that anecdotal evidence suggests is unfair. While more clients of wealth managers than before confess to be disappointed with the service they receive, many remain ignorant of just how bad and expensive that service is.
It is a similar story with active fund management. Compared to 20 years ago, there is no doubt that awareness of the importance of costs is much greater than it was, but the persistence of so many expensive funds that deliver below par performance is striking, despite disclosure requirements that make the potential impact on total returns explicit (or would do if anybody bothered to read them). Once again the best way to bring this home would be to provide an audited and objective analysis of the true cost – actual and opportunity cost – of historic performance. Yet few seem bothered to ask, let alone to make the effort to discover the answer to this relatively simple question.
As Bill Gross of Pimco pointed out over the summer, one of the many disquieting aspects of the current economic environment is that zero interest rates and massive Government intervention have hugely raised the opportunity cost for investors who carry on the way they have done in the past, while also serving to dampen what can be realistically be expected in the way of future returns when the unprecedented stimulus finally comes to an end.
The unspoken aim of Government policy now is to recapitalise the banks by leaving depositors with minimal returns from cash and short term Government bonds, and allowing the banks to make easy, privileged geared returns from their artificially low funding costs. The inevitable price to be paid for this in the short term (though it is a reward for those who understand what is going on) is asset price inflation. In the longer term the price will be the return of price inflation itself and almost certainly slower economic growth.
Jonathan Davis 