What Do You Believe About Investing?
Until recently, investors found great comfort in their traditional models. This was a world where products trumped risks; computers trumped people; the quantitative trumped the qualitative; and top-down trumped bottom up. And then those investors took the red pill... and woke up in the real world.
‘Not everyone believes what you believe.’ ‘My beliefs do not require them to.’
In the wake of the Asian financial crisis, the Long-Term Capital debacle, the Internet bubble and bust, the ‘perfect storm’, the global financial and sub-prime crisis, and, now, the European debt crisis, you’d be forgiven for throwing out your old finance textbooks and taking out your own blank piece of paper and pen. There are many in the institutional investment community that feel as if they ‘took the red pill’ and wound up shooting down the rabbit hole... only to find that the real world isn’t all that easy a place to operate.
Until recently, pension and sovereign funds found great comfort in their traditional financial, investment and risk models (CAPM, MPT, EMH, MVO, VAR, etc). This was a world where products trumped risks; computers trumped people; the quantitative trumped the qualitative; and top-down trumped bottom up. It was a simplified world based on assumptions and abstractions and a faith that zeros and ones could communicate the information required for strategic decisions. Once a refuge, however, institutional investors have since come to see this as a ‘world that was pulled over their eyes to blind them from the truth.’ (Or, at the very least, an unnecessary distortion from the underlying assets and risks.)
In short, many investors are now operating in a ‘post-modern portfolio theory’ world. But what does the Post-MPT world look like? It’s important to actually come up with some answers to this question, because long-term investing is extremely challenging. It requires savvy investors to consider and understand the fundamental drivers of economic value over the long term. But these ‘drivers’ aren’t as self-evident as we once thought they were. No doubt someone like Ray Dalio could rattle off the truths that he holds to be self-evident; truths that guide his day-to-day decision-making. Can you?
All this is to say, as the traditional models fall out of favor, investment beliefs will become increasingly important. To put it rather complicatedly, they represent the financial ontology and investment methodology that you believe will help you meet your investing objectives over the long run. Put less nerdy, investment beliefs are the assumptions – which inform your decision-making – about the way the financial and investing world actually works. They’re important because they’re the foundation for the resourcing and investment decisions that come later.
So, ask yourself, after two decades of incessant crises, what is it that you believe about the business of investing and the behavior of financial markets and agents? And, if you actually have cogent views on this subject and can articulate those views, how do they affect the way you actually deploy your capital? After all, what we believe about finance and investment drives what we buy and sell.
So what replaces the traditional tools and their underlying assumptions? In other words, how do you develop a useful set of beliefs for the real world?
Let me refer you to Bryan Thomson’s comment from a recent Pacific Pension Institute’s newsletter that I think is spot on:
“Investment beliefs should begin at a high level and be used to provide guidance on appropriate behaviors. As you can see, each would not only influence investment strategies, but human resource policies, codes of conduct, how we deal with clients and the broader financial markets as well. As such, each could then be filled out with specific actions.”
Bryan then offers up four investment beliefs that he thinks are valuable:
“Ethics Count – Ethical behavior is fundamental to long-term, sustainable performance. We believe that the best results are achieved by firms that adhere to the highest ethical standards in their activities and requiring those same standards of those with which they do business. We will continuously strive to maintain the highest ethical standards by reinforcing these values to our staff and external partners.
Skill Matters – The skill of our employees is the foundation of successful long-term performance. Our belief is that long-term investment returns depend on the skills and abilities of our employees. We will rigorously recruit, train and retain a highly motivated and dedicated staff for managing our clients’ assets.
Engagement – Engagement is crucial to successful long-term performance. Our belief is that long-term investment returns are impacted by a number of systemic issues that require engagement at the company, national and international level. Amongst these issues are sound corporate governance, strong environmental standards, social responsibility; fair, efficient and safe capital markets; fair treatment of shareholders by governments, sound pensions systems, and climate change. By engaging on these issues on behalf of our clients we will improve their investment returns.
A Strategic Focus – A strategic focus guides our investment process. We believe in long-term trends in the capital markets and structure our asset allocation to take advantage of these secular movements. Central to this approach is diversifying our asset allocation amongst the traditional asset classes; reducing volatility through a commitment to real assets holdings and, adding value through active management where and when that opportunity is compelling. Through this strategic focus we aim for a stable and consistent return pattern while ultimately meeting our clients’ return objectives.”
I think Bryan’s beliefs offer a useful framework for thinking about the real world. These beliefs offer a framework for guiding the organization through volatility and challenges. But, remember, this isn’t an exhaustive list. I’ve seen other beliefs that I personally found extremely useful. But it’s really not my place to describe all the beliefs I think are valuable or try to impose my beliefs on you. The process of actually coming up with beliefs and then writing them in a way that they can be mobilized and executed is profoundly useful for investment organizations.
But to do this, you’ve got to let go of the old world. You’ve got to recognize that you’re operating in ‘the desert of the real’ where complexity and idiosyncrasy cannot be captured by a model in a machine. Ironically, as I’m writing this post an article popped into my twitter feed entitled ‘Challenging the Long-Held Belief in Shareholder Value’. This is where we’re headed. Free your mind of the traditional models and assumptions and start thinking about ‘how the world works’...
You think that’s air you’re breathing now?