Monday, December 29, 2014

The Price One Pays to Avoid the Risk of Negatively Standing Out

Some great quotes passed along to me by my good friend Lincoln:

Doctors who understand why we get fat and what to do about it are obviously hard to find; otherwise, this book wouldn’t be necessary. The truly unfortunate fact is that even those doctors who do understand the reality of weight regulation often hesitate to prescribe carbohydrate restriction to their patients—even if this is how they maintain their own weight. Physicians who tell their fat patients to eat less and exercise more, and particularly to eat the kind of low-fat, high-carbohydrate diet that the authorities recommend, will not be sued for malpractice should any of those patients have a heart attack two weeks or even two months later. The doctor who goes against established medical convention and prescribes carbohydrate restriction has no such safeguard.

--Gary Taubes, Why We Get Fat

I’m convinced that for many institutional investment organizations the operative rule – intentional or unconscious – is this: “We would never buy so much of something that if it doesn’t work, we’ll look bad.”  For many agents and their organizations, the realities of life mandate such a rule.  But people who follow this rule must understand that by definition it will keep them from buying enough of something that works for it to make much of a difference for the better.

In 1936, the economist John Maynard Keynes wrote in The General Theory of Employment, Interest and Money, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally” [italics added].  For people who measure success in terms of dollars and cents, risk taking can pay off when gains on winners are netted out against losses on losers.  But if reputation or job retention is what counts, losers may be all that matter, since winners may be incapable of outweighing them.  In that case, success may hinge entirely on the avoidance of unconventional behavior that’s unsuccessful.

--Howard Marks, Dare to Be Great II

If the behavior of institutional investors weren't so horrifying, it might actually be humorous. Hundreds of billions of other people's hard-earned dollars are routinely whipped from investment to investment based on little or no in-depth research or analysis. The prevalent mentality is consensus, groupthink. Acting with the crowd ensures an acceptable mediocrity; acting independently runs the risk of unacceptable underperformance. Indeed, the short-term, relative-performance orientation of many money managers has made "institutional investor" a contradiction in terms….

The pressure to retain clients exerts a stifling influence on institutional investors. Since clients frequently replace the worst-performing managers (and since money managers live in fear of this), most managers try to avoid standing apart from the crowd. Those with only average results are considerably less likely to lose accounts than are the worst performers. The result is that most money managers consider mediocre performance acceptable. Although unconventional decisions that prove successful could generate superior investment performance and result in client additions, the risk of mistakes, which would diminish performance and possibly lead to client departures, is usually considered too high.

--Seth Klarman, Margin of Safety