songs my portfolio manager taught me (part 2)

things of potentially general application

an occasional series (or at least, it is now I’ve done a second one) of reminiscences from my previous career, taking maxims from the world of investment and finance and trying to apply them to daily life, rather than vice versa …

Once upon a time, in the early to mid stages of the Global Financial Crisis, a client said to me …

“Danny, since this thing began, there have been two types of analysts. Some people, like yourself, have been trying to develop their understanding of an incredibly complicated system, under huge pressure, absorbing vast amounts of technical detail in a short time, and doing a fairly good job of it. Others have just been mindless bomb-throwers, trying to attract attention to themselves with ill-informed displays of competitive panic. I decided early in this crisis that I was going to listen to the second type of analyst – and they have turned out, systematically, to be much closer to being right”

He was correct; I changed my approach as a result and consequently, I think, did a much better job of understanding the Eurocrisis. There’s a very great danger in believing that either a) the whole problem is of a size that you can fit in your head, so understanding it is just a matter of working hard enough, or that b) the relationship between the amount of detail you know and your understanding of the system is positive and monotonic. This is often not the case.

(This is one of the reasons I am always sceptical of suggestions to have “elementary statistical reasoning” taught in schools, usually so we wouldn’t vote Brexit or some such. Quite apart from all the other issues, I have seen the behaviour of actual professors, and am thus pretty sure that if you taught most people better quantiative reasoning techniques, they would mainly use them to dig deeper and more robust rabbit holes).

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“You don’t win a yacht race by forecasting the wind, you win it by trimming the sail”

This was a second-favourite proverb of a boss who usually preferred to express the same idea by saying “I’ve always found it easier to short-sell a stock when it’s going down, not when it’s going up”. In a lot of systems (central banks are particularly bad at this, for all that they try not to be), people are fixated on trying to predict the medium term future, when they actually ought to be concentrating on making sure they are fully aware of the recent past.

As a description of sailing races, by the way, that proverb’s not quite right. You win a sailing race by keeping a dual focus; very aware of the direction and strength of the wind acting on your sails right now, with an eye out toward the horizon to see whether there’s something big heading in your direction. It surprises me a lot that few other systems adopt this kind of approach; when people try to base things off forecasts, they usually base things on root-mean-square errors, and consequently spend most of their effort on exactly that medium-term, three-to-five year horizon which is the most useless; you miss the big megatrends which are most likely outside it, but you also miss things that are happening right now because your model tells you they’ll likely mean-revert.

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And finally, one that wasn’t really about investment, but it cracked me up so much that I’ve remembered it for decades. We were on a marketing trip seeing hedge fund managers, and we were meeting some mid-size fund somewhere in Connecticut for the first time. The manager had clearly bought one of those tear-off calendars called “365 Annoying Things For Morons To Say In Meetings”, and began the show by regaling us with that day’s wisdom:

“You know what I want from my brokers? Commitment. Look, I had bacon and eggs for breakfast today and I’ll tell you what the difference was. There was a hen and a pig making my breakfast - the hen was involved but the pig was committed”.

I sat there, squirming in embarrassment that a grown man had said that as if he thought it was clever. My partner adopted a thoughtful expression and replied:

“I see. But surely when you want some breakfast tomorrow, the hen will have laid another egg, but the pig won’t have made any more bacon?”

Have a good weekend everyone.