Though I've taken some decent-sized potshots at the sell-side, I confess to be moderately saddened at the impending retirement of Eric Miller as the investment strategist of Donaldson Lufkin & Jenrette. I haven't met him, he isn't a client and we aren't related, but as someone in the investment business who has always wanted to write (thanks again, TSC), I have always been impressed by his prose and the breadth of his thinking. The latter is of particular interest because what makes an investor successful is the ability to make sense of the flotsam and jetsam that pass for daily news and analysis on Wall Street, and then have the guts to apply it. I have a commentary folder over the years that details not only Miller's but other so-called smart guys' thinking, from which I've nipped here and there.
Miller's recent column was on a recent meeting of the "Financial Behaviorists," who propose a theory that isn't really new but is drawing adherents because it can be discussed without pages of mathematical equations or a mainframe computer. This theory has also drawn a number of people with Ph.D.'s in psychology and statistics, sucked in by the carrot of a high-paying job at
. The semiannual conferences are usually held at places like Harvard's
, under the assumption I guess that the real smart guys are mostly from the East Coast and they can save on airfare if they keep it local.
The Behaviorists are value-oriented investors who hold that much of
Modern Portfolio Theory
is nonsense, that investors overreact to both good and bad news, and that therefore a practical goal of investment management is to find the anomalies that these overreactions create, profit on the mistakes of others and avoid the temptation to succumb to personal bias.
I've always quoted someone (attribution unknown) who said that a smart person in the investment business can make all the mistakes one can make in five years. The key to a successful career is to avoid making the same mistakes over and over. Miller lists some common biases:
Comfort with the status quo.
Illusions as to what you can control.
Selective memory (my favorite).
Ignoring chance and uncertainties.
Being more sensitive to losses than to gains.
Exaggerating skills (another personal favorite).
A number of these issues are pertinent to today's market, with the first being the screamer. The status quo issue also hits close to home, since I am a value-oriented investor.
I have some clients who split their pension money between us and a growth manager. The growth manager comes in and talks about the so-called status quo stocks, like
and how wonderful they are. It is a powerful presentation that everyone in the world can immediately appreciate, particularly with the recent performance of the largest of the large-cap consumer growth companies.
Then I come in and talk about how miserable
business is, how they are getting clobbered in the Far East, the fact that the stock has gone nowhere for four years and therefore we're buying it. Not surprisingly, I wouldn't do well if a poll was taken the next day. It isn't easy to buy something when everyone else has just sold it and is listing its many problems. As Miller says, "It's just more fun to own sexy stocks that you can order right off the popularity menu."
The tendency to extrapolate the recent past into a highly uncertain future and to find comfort in the status quo has led to an enormous body of academic work that strongly favors a value orientation over a growth orientation. The tendency is also applicable to mutual funds and money managers chasing the hot performance. Investors bring unsustainably high expectations to the popular feast, and the price of admission is so high as to invite disappointment and punishing capital losses.
Value works over time because it is a strategy of winning by not losing. Value investing is lonlier, because most people think value investors "don't get it," and who wants to hang out with a crank who's always taking potshots at popular conventions and investing in things that take time to understand?
Miller then lists some bad investing habits that biases can lead to:
Trading too much.
Selling winners and keeping losers.
Seeking confirming evidence when you need a devil's advocate.
Looking at your portfolio too often.
Losing perspective about risk.
So what's your problem?
Tell us your biggest (investing) problem with a good example, and your full name, and we'll post some.
Jeffrey Bronchick is a portfolio manager and principal with the investment firm of Reed Conner & Birdwell. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reed Conner & Birdwell is based in Los Angeles and manages about $1 billion of assets for institutions and taxable individuals. Bronchick's column, The Buysider, appears every Tuesday on TheStreet.com.