Jeffrey Ubben is a hedge fund manager who is the co-founder and CEO of ValueAct Capital, known for his hands-on activist approach to investing. Unlike many other activist investors, ValueActâs modus operandi is to work with management to reach mutually beneficial resolutions to problems, which is a far cry from the bullying tactics sometimes used by others in the field. In this interview, Ubben offered his opinion on a number of important investment issues.
The difference between volatility and real risk
âIn my world, the investment world, there are two forms of risk: Thereâs volatility -- things that go up and down with attendant anxiety, and thereâs loss of principal. This is real risk; this is permanent. In the short term, anything can happen. Michael Lewis writes in âMoneyball,â which is really a business book, about Billy Beane and how he understands that good process can result in bad outcomes and bad process can result in good outcomes, over the short term. Thatâs what I call volatility. Volatility is actually the opposite of risk; volatility is opportunity.â
This is an idea that we have explored in the past. Many people mistake volatility for risk, but for most investors, volatility should be viewed as a source of opportunity. In the short term, following a value approach will probably cause your portfolio to underperform the market, but your principal is more likely to be preserved. There are cases in which volatility can represent real risk, however: Investors who are short volatility, either by being positioned long and short, or by being short a product like the CBOE Volatility Index (VIX) futures, will naturally be harmed if volatility rises.
Hot hands do not exist
âYou need to think through and fight some basic human weaknesses. Ninety-one percentĂ of people surveyed believe in the hot hand [in basketball]. In fact, it doesnât exist. But our brain gets very thrilled by the the guy whoâs going to hit the next jumper. We trust our feelings and perceive patterns that donât actually exist, and a player who thinks he has a hot hand often has a distorted sense, and he takes bad shots. The best shooters, by the way, think theyâre always cold, and when their feelings tell them to take the shot because when they have the hot hand, they donât listen.â
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The hot hand fallacy is the inverse of the gamblerâs fallacy, wherein the casino-goer sees red come up 10 times in a row at the roulette table and thinks that that means black "has to" come up next. In fact, isolated iterations of coins flips or roulette spins are statistically independent (assuming the game is not rigged), and therefore the outcome of the next spin does not depend on the previous one. The probability of your next stock pick being a winner is not affected either way by the success or failure of your previous one.
Make all the mistakes you can
âChess masters will tell you that what makes them great is not the quantity of practice, itâs the quality. They spend most of their time after matches reviewing their decisions that were bad. Self-criticism is the secret to self-improvement. Negative feedback is a good thing. The physicist Niels Bohr once said, 'The definition of an expert is one that makes all the mistakes you can make in a very narrow field.' Mistakes are not to be discouraged. On the contrary, they should be cultivated and carefully investigated.â
Learning from your mistakes is the only way to truly improve. The right way to do something is achieved by first discarding all wrong ways to do something. In his book "Antifragile," the trader-philosopher Nassim Nicholas Taleb writes that organic systems (human bodies, economic systems, companies and so on) gain from chaos and disorder. In much the same way, your investment strategy should be guided by the mistakes that you make. There is no shame in being wrong, only in failing to learn from being wrong.
Disclosure: The author owns no stocks mentioned.
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