December 2, 2013
A Rational Perspective
Before any blog of mine hits the web, I spend time traversing the internet for information worth the attention of long term investors. My goal is to provide valuable articles weaved into a short narrative that helps serious stewards of capital take a rational look at the investment marketplace. It’s an arduous task weeding out valuable information for long term investors from the prognostications of various investment industry opinion makers. Though the media and much of the industry encourage the practice - trying to predict future events is irrational. Turns out that as investors we’re better off not listening to opinions or forecasts at all - certainly if we want to garner our fair share of market returns over any meaningful time period.
True investment success, in the form of capital preservation and sustained long term growth that meets spending needs, and outpaces inflation and costs, comes from disciplined adherence to a well-articulated investment process, one with rational expectations of the market through good times and bad. As the most successful investing duo of all time will attest, investors who experience long term success are no more intelligent than others, they are more rational. Put another way, their temperament is superior to that of the majority of investors. They possess the self-awareness necessary to acknowledge their human inclination to speculate, and they move beyond their emotions in favor of a disciplined decision making process.
Today, rational investors understand that the double digit returns most asset classes have delivered over the nearly 5 years since the financial crisis has lowered long term return expectations for those assets going forward. So it is curious that a recent survey found institutional investors (those investment professionals and Board members who are intelligent, successful folks with investing on behalf of organizations with long time horizons) are currently dumping alternatives in favor of equities. In the post-crisis turmoil, these same investors advocated reducing equities and increasing alternatives (the asset class whose returns were least bad in 2008). 5 years later they are leading the charge to chase performance once again.
A recent study found investment consultants actually exacerbate this irrational behavior by utilizing past performance, a defensible metric in the eyes of their committees/clients, to substantiate capital allocation decisions even though they understand that significant recent appreciation of an asset class without corresponding growth in earnings correlates to lower returns going forward. It doesn't seem like these ostensibly smarter, more intelligent investors are engaged in a disciplined, long term and independent decision making process.
The reality is that most investment industry business models are not structured to help investors properly assess performance and its implications. Instead many simply feast on an investing herd seduced by market sentiment and guided by the stubborn heuristic that attributes great skill to recent outperformance. As the market appreciates further and further, the practice becomes more pronounced. This article from Harvard Business Review aptly associates such a culture with the flawed decision making that led to the Challenger disaster.
Proper performance assessment requires a large sample size of returns through good and bad market cycles measured against relevant benchmarks. Rational investors also look beyond a set of quantitative measures to ensure their investment is performing as expected in the prevailing environment. And in this current environment, they aren’t hesitating to speak candidly about lower long-term market expectations.
Warren Buffett once put it this way, “speculation is most dangerous when it looks easiest.” Maintaining a rational outlook is never easy, and with the help of the investment industry most investors fail to do so in times of rising optimism or pessimism. Though there are plenty of opinions out there, nobody knows the future, but long term investors can overcome this inescapable fact with a disciplined investment process and a rational outlook.
Robert P. Edmiston
Bob is an Investment Officer with Hirtle Callaghan and works with the firm’s clients in Central PA, Eastern PA and New Jersey. Prior to joining the firm Bob worked with The Vanguard Group as a Registered Representative where he was most recently responsible for Institutional Retirement Plan education services. During his time traveling throughout the United States in this role, Bob engaged approximately 21,000 investors on the subject of prudent retirement savings and investment decisions. Bob also gained client service experience at the beginning of his career managing 400 high net worth client groups at Vanguard. Bob holds an M.B.A. from Penn State University and received his B.A. in Economics and Sociology from The University of Maryland.