As Lehman Brothers crumbles, I think few would question that many on Wall Street are losers. To take it a step further, I believe there is no question that investment management is truly a loser’s game. This was first elucidated by Charles Ellis in a seminal 1974 paper in the Financial Analysts Journal. Ellis defines a loser’s game as any competition where the outcome is decided by the loser’s actions, as opposed to the actions of the winner. For example, only at the top level of sport do the skillful moves of the winner determine the victor. Ellis uses tennis as an example (as cited in a book by Simon Ramo), where most matches are won by he who makes the fewest errors. Only the very best players WIN points, the rest of us LOSE points. The way to win a loser’s game is to lose less than your opponent.
The parallels to money management are strikingly obvious. What are Buffet’s first rules of investing? Rule #1: Don’t lose money Rule #2: Don’t forget Rule#1… Even Buffett, who would likely be at or near the top of anyone’s list as a “winner” knows that investing is a loser’s game. Yet most Wall Streeters are always trying to win, to make more money than then the other guy, thereby eliminating the possibility of a winner’s game existing. As Ellis said:
“The trouble with winner’s games is that they tend to self-destruct because they attract too much attention and too many players - all of whom want to win.”
Even back in 1974 Ellis realized that the stock market was changing, that money managers were no longer competing against amateurs who had limited access to information, they were competing against themselves. 34 years later, that phenomenon is now exponentially more true. Anyone and everyone has instant access to the same financial data, news, and trading resources.
We can certainly extend this thesis to banking. As the big boys all sought to beat each other they failed to consider the downside, failed to consider the possibility that they might lose it all. Those who played conservatively, who understood that they were playing a loser’s game, live on. Lehman thought they were playing a winner’s game - they still do. Perhaps this is fed by the fact that intelligent people, as Ellis says, are so proficient at developing and articulating “self-persuasive logic to justify the conclusions they want to keep.”
Does all of this then lead me to embrace Efficient Market Theory - the notion that at any time liquid assets are priced “correctly” and hence it is futile to try to beat the market? Absolutely NOT! You need look no further than the tech bubble or even recent real estate pricing to prove to yourself that assets are frequently mis-priced. The problem is that active managers in aggregate cannot beat the market net of expenses - they are the market after all. Can some managers beat the market consistently? I believe they can. But how does one indentify these managers before the fact? That is a topic for another post, but I believe it has to do with process and environment. The very environment in which most mutuial funds and brokers operate unequivocally eliminates any chance of outperforming the market.
How then should thoughtful investors operate within this loser’s game? Ellis provides some excellent insight via military and sports analogies. The parallels to Graham and Buffet’s “game plan” are striking.
First, says Ellis, make sure you are playing your own game:
“Impose upon the enemy the time and place and conditions for fighting preferred by oneself.” - Admiral Morrison
“Give the other fellow as many opportunities as possible to make mistakes, and he will do so.” - Ramo
Buffett:
“We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitley!”
“We only think about the pitches we swing at… It’s the “Swing, you bum!” from the stands that makes you swing at bad pitches.”
“The market is there only as a reference point to see if anybody is offering to do anything foolish”
Second, keep it simple. “Try to do a few things unusually well.”
“Play the shot you’ve got the greatest chance of playing well… Simplicity, concentration and economy of time and effort have been the distinguishing feature of the great players’ methods, while others lost their way to glory by wandering in a maze of details.” - Tommy Armour on golf
Buffett:
“Draw a circle around the businesses you understand… The most important thing in terms of your circle of competence is not how large the area of it is but how well you’ve defined the perimeter.”
“If you have to go through too much investigation, something is wrong.”
“If calculus or algebra were required to be a great investor, I’d have to go back to delivering newspapers.”
“Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count.”
Third, and this one is really key and something that even Buffett has admitted to messing up: invest defensively by concentrating on selling. Ellis says too much time is spent on the buying decision - one should focus more on selling. As he says,
“Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the loser’s game.”
I plead guilty to this myself and have made a concerted effort to reduce fully valued holdings in my portfolios.
If we agree that money management is in fact a loser’s game, then the simple way to succeed is by losing less. Avoid trying too hard, or stretching for results. Following this simple advice would have prevented the entire housing crisis and the collapse of Bear Stearns and Lehman. Of course that is asking way too much of Wall Street, for Wall Street full of nothing but “winners”.
Of course, as Ellis said, “only a sucker backs a “winner” in the loser’s game…”
The parallels to money management are strikingly obvious. What are Buffet’s first rules of investing? Rule #1: Don’t lose money Rule #2: Don’t forget Rule#1… Even Buffett, who would likely be at or near the top of anyone’s list as a “winner” knows that investing is a loser’s game. Yet most Wall Streeters are always trying to win, to make more money than then the other guy, thereby eliminating the possibility of a winner’s game existing. As Ellis said:
“The trouble with winner’s games is that they tend to self-destruct because they attract too much attention and too many players - all of whom want to win.”
Even back in 1974 Ellis realized that the stock market was changing, that money managers were no longer competing against amateurs who had limited access to information, they were competing against themselves. 34 years later, that phenomenon is now exponentially more true. Anyone and everyone has instant access to the same financial data, news, and trading resources.
We can certainly extend this thesis to banking. As the big boys all sought to beat each other they failed to consider the downside, failed to consider the possibility that they might lose it all. Those who played conservatively, who understood that they were playing a loser’s game, live on. Lehman thought they were playing a winner’s game - they still do. Perhaps this is fed by the fact that intelligent people, as Ellis says, are so proficient at developing and articulating “self-persuasive logic to justify the conclusions they want to keep.”
Does all of this then lead me to embrace Efficient Market Theory - the notion that at any time liquid assets are priced “correctly” and hence it is futile to try to beat the market? Absolutely NOT! You need look no further than the tech bubble or even recent real estate pricing to prove to yourself that assets are frequently mis-priced. The problem is that active managers in aggregate cannot beat the market net of expenses - they are the market after all. Can some managers beat the market consistently? I believe they can. But how does one indentify these managers before the fact? That is a topic for another post, but I believe it has to do with process and environment. The very environment in which most mutuial funds and brokers operate unequivocally eliminates any chance of outperforming the market.
How then should thoughtful investors operate within this loser’s game? Ellis provides some excellent insight via military and sports analogies. The parallels to Graham and Buffet’s “game plan” are striking.
First, says Ellis, make sure you are playing your own game:
“Impose upon the enemy the time and place and conditions for fighting preferred by oneself.” - Admiral Morrison
“Give the other fellow as many opportunities as possible to make mistakes, and he will do so.” - Ramo
Buffett:
“We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitley!”
“We only think about the pitches we swing at… It’s the “Swing, you bum!” from the stands that makes you swing at bad pitches.”
“The market is there only as a reference point to see if anybody is offering to do anything foolish”
Second, keep it simple. “Try to do a few things unusually well.”
“Play the shot you’ve got the greatest chance of playing well… Simplicity, concentration and economy of time and effort have been the distinguishing feature of the great players’ methods, while others lost their way to glory by wandering in a maze of details.” - Tommy Armour on golf
Buffett:
“Draw a circle around the businesses you understand… The most important thing in terms of your circle of competence is not how large the area of it is but how well you’ve defined the perimeter.”
“If you have to go through too much investigation, something is wrong.”
“If calculus or algebra were required to be a great investor, I’d have to go back to delivering newspapers.”
“Investors should remember that their scorecard is not computed using Olympic-diving methods: Degree-of-difficulty doesn’t count.”
Third, and this one is really key and something that even Buffett has admitted to messing up: invest defensively by concentrating on selling. Ellis says too much time is spent on the buying decision - one should focus more on selling. As he says,
“Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the loser’s game.”
I plead guilty to this myself and have made a concerted effort to reduce fully valued holdings in my portfolios.
If we agree that money management is in fact a loser’s game, then the simple way to succeed is by losing less. Avoid trying too hard, or stretching for results. Following this simple advice would have prevented the entire housing crisis and the collapse of Bear Stearns and Lehman. Of course that is asking way too much of Wall Street, for Wall Street full of nothing but “winners”.
Of course, as Ellis said, “only a sucker backs a “winner” in the loser’s game…”
