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Michael Mauboussin is the chief investment strategist at Legg Masson Capital Management, an adjunct professor of finance at Columbia Business School and author of three books.
These are Mr. Mauboussin’s views:
Investments timing
· There are some return statistics that investors might not like: The S&P averages 9 percent annually, 7.5 percent is what mutual funds earn and the individual investor in mutual funds averages 5.5 to 6 percent. So investors generally get around 60 to 70 percent of the market’s returns.
· These results are basically due to bad timing. Most fund investors tend to buy when reported earnings are attractive and sell after a poor performance. So, they buy high and sell low.
· Not only individuals underperform, institutional investors are also victims of short-termism. One-third of the underperformance is attributable to asset allocation and two thirds to managers. American ethic equates hard work to better results, which is not always true in the investing world. Many managers,
endowments and pension funds think that moving money around is the way to improve performance, but then again, their timing tends to be very poor.
· Per the hot hand metaphor, most people believe that if they have done well recently, the winning streak is more likely to continue. When the opposite occurs, then there is a higher probability to do poorly. Statisticians have research the hot hand for years and at best there is little evidence for it. The problem is that we still act as if it was fact.
Buy and hold.
· It is not buy and hold tat matters; it is buy cheap and hold that works.
· Michel Mauboussin told a story about Bob Kirby (one of the founders of Guardian Capital in California). Bob was running the portfolio of a woman, following all of the firm’s advice for buying and selling. He was placing the orders through the woman’s husband. Every time there was a buy recommendation, the husband would purchase $5,000 for his own account and forget about it. When the husband died, the wife asked Bob to merge both accounts; when he looked at the husband’s account he discovered, to his surprise, that the man had followed the recommendations only on the buy side. But, he was astonished to find that the account had risen to too much greater value than the wife’s. There was one company that did extremely well: Xerox (XRX).
· There is a study over 3,000 endowments and pension funds. The research showed that their basic strategy was to hire managers that had recently outperformed the market and fire those that had underperformed. Over the next 24 months, the managers that had been fired did better than the recently hired ones. Had these sponsors done nothing but to sit and wait, they would have been better off.
· So, instead of the hot hand, investors should bear in mind the regression toward the mean principle. Thus, if things have been going very well, the most likely next move is down and vice versa.
· The typical investment horizon is about three years. Nevertheless, Mauboussin thinks this is too short a period for many of the strategies to work. Nowadays, short-termism is ubiquitous both at corporations and at money managers.
Is superior performance the result of prowess or luck?
· The “Paradox of Skills” states that when people compete with one another, the more skillful they are, the more uniform their results will be and the more relevant luck becomes. With very low barriers to entry, the investing business is very competitive and luck is preponderant. This is another way to refer to the Efficient Market Hypothesis.
· However, Mauboussin admits that the degree of skill determines where the means are set. (Thus, investments are not pure luck and a savvy investor, unrestricted by the organization will tend to get better results*.)
· So if 3, 5 or 10 years might not be enough, what can you do? Well, evaluate the manager. The assessment process takes three steps:
· This process takes a lot of work. If investors do not want to do that, then indexing is a plausible option.
Ø Focus on the managers’ analytical process. How do they seek and analyze opportunities?
Ø Learn the behavioral aspects of the manager, the psychology. Do they know about the latest findings in behavioral finance?
Ø Is the organization an adequate environment for the manager to perform? Are there constraints strong enough to make the manager lag the market? Is the firm content with its managers staying with the pack?
Conclusions:
Michael Mauboussin tell us that one of the more important aspects in analyzing funds is not to expect the winning or losing streak to continue. Buying when funds had an outstanding year and selling because the fund did poorly are one of the main reasons why investors receive, on average, 60 to 70 percent of the market returns. As fund investors, we would better concentrate on assessing the managers’ processes to select and sell securities, their knowledge in areas such as behavioral finance and their psychology, and to determine whether the organization in which they operate nurtures or hinders performance.
For the individual investors, who like to build and manage our portfolio, it might possible to state that Michel Mauboussin advises us to do the best analysis we can, determine our entry and exit prices
and be patient. It is also key to make an objective, as objective as it can be, assessment of ourselves. What about our processes to analyze, follow up, buy and sell stocks? Do we have the adequate competences to discern the psychology of the markets? How well do we know ourselves? Are we capable of selecting individual stocks? Or are we better off having someone else doing it for us? How does our performance compares with that of top performers and the market’s’?
*Writer's note.
The interview:
Steve Forbes interviews Michael Mauboussin
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