Warren Buffett is not an easy person to impress. I recently picked up a book “The Most Important Thing” by Howard Marks after Buffett said, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.” If you haven’t read it yet, I highly recommend it, available here: https://www.amazon.ca/Most-Important-Thing-Uncommon-Thoughtful/dp/0231153686
The excerpt below stuck out in particular. I think a lot of investors make the mistake of assuming a higher price is the sign of a good decision, and a lower price the sign of a bad one. Marks looks at the issue differently, more correctly. He explains how to tell the difference between a good random outcome, and real skill.
Investors are right (and wrong) all the time for the “wrong reason.” Someone buys a stock because he or she expects a certain development; it doesn’t occur; the market takes the stock up anyways; the investor looks good (and invariably accepts credit).
The correctness of a decision can’t be judged from the outcome. Nevertheless, that’s how people assess it. A good decision is one that’s optimal at the time it’s made, when the future is by definition unknown. Thus, correct decisions are often unsuccessful, and vice versa.
Randonmness alone can produce just about any outcome in the short run. In portfolios that are allowed to reflect them fully, market movement can easily swamp the skillfulness of the manager (or lack thereof). But certainly market movements cannot be credited to the manager (unless he or she is the rare market timer who’s capable of getting it right repeatedly).
For these reasons, investors often receive credit they don’t deserve. One good coup can be enough to build a reputation, but clearly a coup can arise out of randomness alone. Few of these “geniuses” are right more than once or twice in a row.
Thus, it’s essential to have a large number of observations – lots of years of data—before judging a given manager’s ability.
Too frequently I see investors make an investment case based on only a year or two of data – an amount far too short to reflect the variability seen over real market cycles lasting four to five years. The problem is even more widespread in real estate, where full cycles last upwards of 15 to 20 years. In either case, with an understanding of process over outcome, we can better separate who’s speculating on a wave of increasing credit availability, and who’s investing for real sustainable long term cashflows.
What I’ve been reading this week:
Confidence is not a sign of skillfulness. It’s often the opposite. http://www.mbird.com/2011/10/daniel-kahneman-on-overconfidence-and-the-illusion-of-validity/
A list of the best annual Chairman’s letters: http://jasonzweig.com/the-best-annual-letters-from-an-investor-who-read-nearly-3000-of-them/
We are ripe for value to make a big comeback: http://www.pzena.com/Cache/1001211922.PDF
Funny jokes from the Clinton/Trump laugh-in: http://www.bloomberg.com/politics/articles/2016-10-21/clinton-and-trump-trade-hostility-for-humor-at-al-smith-dinner