“I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”. That was one of the first epigrams from Warren Buffett that caught my attention twenty years ago when I was researching a thesis on the Sage of Omaha’s stockpicking methods at MIT. What belatedly dawned on me the other day was that something similar might just as easily these days be said about the fund management business: “Try to buy a fund whose investment style is so simple that your kid’s computer could run it. Because sooner or later, one will”.
“Thinking, fast and slow” by the Nobel prize-winning psychologist Daniel Kahneman continues to ride high in the business book bestseller lists. I dare say therefore that copies have found their way into the hands of managers of investment firms. But how many of them, I wonder, have reflected on the implications for the businesses in which they are involved – and how many, alternatively, have quietly binned the book as too disturbing to risk leaving lying around the office?
The damning money-weighted rates of return analysis carried out by Simon Lack in his book The Hedge Fund Mirage has prompted a useful debate about the true returns recorded by hedge funds. Industry lobbyists have not had much luck in undermining his critique, which is hardly surprising as the data, interpreted correctly, is essentially unanswerable (the conclusions you draw from the data is another matter).
The news that George Soros is throwing the last outside investors out of his Quantum fund and keeping it solely as a family office from now on provides a useful reminder that hedge funds are facing increasing obstacles, of which the regulatory requirements which prompted this move are just one. If they go back to being what they once were, namely private pools of capital with a finite number of owners and fend-for-yourself regulation, the investment world would, in my view, be no worse a place as a result.
Who said: “Investment results largely depend on how one behaves near the top and near the bottom” [of the market cycle]? The answer is Keynes, whose remark is quoted in a collection of some of his most famous comments about investment in the latest issue of the Journal of Portfolio Management. In my experience, that statement is broadly true, as indeed anyone who cares to think through the implications and study the evidence has to concede.
The three big anomalies in stock market behaviour that academics have identified over the past 50 years are these:
* Small cap stocks tend to outperform large cap stocks over time;
* Value stocks tend to perform better than growth stocks; and
* Momentum, or buying the winners of the recent past and selling the losers, is a surprisingly effective strategy.
Of these three the most recent to be documented, and in some ways the most surprising, is the last.
After all, if it was so easy to put together a winning strategy by following a simple “buy winners, sell losers” rule, you would expect so many investors to adopt the strategy that it would cease to work. This is exactly what happened in the 1980s, when so many investors tried to implement the recently documented small company effect that the strategy stopped working for several years afterwards.
Yet, as Dimson, Marsh and Staunton, the London Business School academics, reported yesterday as they unveiled in London the latest edition of their annual Global Investment Returns survey, the momentum effect has been both powerful and persistent, despite all the publicity that it has attained in recent years, which should by rights have killed it off as an observable phenomenon.