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Know why most Human Fund Managers underperform Markets?

We had a very interesting conversation with a very accomplished industrialist. He is an existing investor into our Global funds and India PMS, and therefore very familiar with our approach to investing.

At the end of half an hour, spent discussing the entire Investment landscape, he said: "It's clear that you own some remarkable companies in your Funds, across the world. But one thing intrigues me: almost all fund managers I meet, can speak for hours about each of their holdings, in an almost poetical manner. How come I have not heard anything of that sort from you? Why the clinical, non starry-eyed view of things?"

That was a very insightful observation, we thought.

Indeed, why is it that almost all fund managers are more lyricist, less the Intelligent Investor?

"Human beings aren't rational animals; we're rationalizing animals who want to appear reasonable to ourselves", said the famous social scientist, Elliot Aronson, author of 'The Social Animal'.

The word around us is a bewildering medley of pure noise.

In such a chaotic daily environment, the brain's protective mechanisms kick in. And that is to batten down the hatches. 

And resort to underanalysed, oversimplified, lazy opinions.

In other words, the brain takes refuge in easy stories.

Remember a famous election?

That was little or no hard evidence, or any cogent articulated strategy about how a country's problems of declining growth and capital Investments would be solved. 

But logic didn't matter. What material was the "Story".

It was a simple story, well told, well sold, that captured the imagination. 

Data and facts were given the short shrift, because most humans are simply incapable of acting on these. 

The world is about tons of data which at times can take random directions. The world is about future probabilities, not certainties...yet the human mind wants a clear cause-effect-future path.

In other words, the world always wants a "Story".

Professional investment managers aren't robots (yet). They are human and love stories. And stories sell.

The interesting thing is that with greater amounts of data being available, the need to "Storify" has increased even more.

This is because human beings are now deluged with tons of data which is impossible to handle.

When a fund manager paints a superficial, yet, magnificent vision of why a particular management has a Midas touch, it is almost always a Story, that has been airbrushed so perfectly that no other room for interpretation, or no other future trajectory can even be mentioned, for fear of attracting contempt. Remember how one could never question IBM, as a stock, at a distant point in history?

So why is a strategy based on 'storification' so risky for investors?

Because when a fund manager gives their holdings a golden future, they ignore discordant, inconvenient, conflicting elements (industry cycle, favorable policy, plain luck).

In other words, they ignore the risks inherent in every single company or industry on this planet.

Storification is dangerous because it paints a Risk-free world, if you invest in a certain group of companies.

Unfortunately, there is no such thing as a Risk Free world.

True Investment Greatness is knowing deeply, all the Risks present in a given Investment, and then deciding what is acceptable risk and what is unacceptable risk. 

Storification, instead, increases attachment to that story. Once an investor or fund manager has become this emotionally invested to a particular stock (eg, ARK Investment to Tesla), they find it impossible to detach themselves from their attachment, even when the facts change. 

Love in Investing is dangerous. 

This is exactly what happened with Warren Buffett and his Coca-Cola Investment. He should have sold this stock several years before he actually did. 

The data is brutal.

Coke has been a rabid underperformer since 1993. 

In fact, Buffett should have bought Pepsi Instead of Coke.

From Jan, 1992 to July, 2020

 

Total Return

CAGR

Coke

798%

7.99%

Pepsi

2966%

12.74%

S&P 500

1273%

9.61%

Why couldn't he sell?

Because he had storified this stock and its management massively and publicly. 

In India, you would have heard the talk that you cannot go wrong buying 'blue chips' or consumer stocks with strong brands, moats & cash flows that are predictable for decades?

This Story is seductive. 

And untrue.

Ever heard of Gillette India, ITC and Colgate? 

They used to be part of this list of storied, branded consumer companies.

Till their stories went sour.

And very quietly, they went out of the list of these so-called Compounders.

This is what is called building a Story around the Survivors, or Survivorship Bias.

As Bill Gates said when Steve Jobs died, "Steve and I will always get more credit than we deserve, because otherwise the story gets too complicated.”

Which brings us to the next point. 

Should you dismiss a story only when it is based on no facts at all? Actually the really dangerous stories are the ones that are true in one tiny part, where there is a small bit of truth but that is used to build a whole edifice which is floating in ether - exemplifying oversimplified, lazy opinions.

As Morgan Housel writes "...something that’s true but incomplete might be more dangerous than something that’s wrong, because a little truth is fuel for a lot of overconfidence."
In the real world, particularly, in markets, things ARE complicated.

But the human mind cannot handle very complicated narratives.

In investing there are always known unknowns. Fashion changes, health trends (eg) against sugary drinks, new product disruptions, policy. The list is endless.

Things are rarely linear in real life for a large basket of companies. But they will always appear to be linear for company selected with complete hindsight or a selection of the survivors.

And based on these survivors, a vision of the future is painted in which absolutely everything is perfect, and as clear as a covid-period sky.

Reality is that, beyond a point nobody knows anything about anything.

Neither company management, nor fund managers, have any clue about what happens a few months down, let alone years.

All this means that the key to being a good investor is being alert and flexible, rather than being married to a story you have built up in your mind.

Always follow the data. Never the fallible Human.

(A version of this article first appeared in Khaleej Times)

From the desk of 

Devina Mehra & Shankar Sharma

If you want any help at all in your wealth creation journey, in managing your Investments, just drop us a line via this link and we will be right by your side, super quick!

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