Unconventional wisdom: Three ways we have it better than professional investors

Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. The more different you are from the person that defined a rule the less you should follow the rule. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.

Unconventional wisdom: Three ways we have it better than professional investors

“Myths do not happen all at once. They do not spring forth whole into the world. They form slowly, rolled between the hands of time until their edges smooth, until the saying of the story gives enough weight to the words—to the memories—to keep them rolling on their own."

- V.E. Schwab

Of the seven hills of Rome two stood out during the height of the republic. One was Palatine the site of the mythological tale of the she-wolf nursing Romulus and his twin brother Remus back to life.

In adulthood Remus occupied the opposing hill of Aventine where he wanted to establish the city. Romulus preferred Palatine and the gods agreed sending twelve auspicious birds to signal their approval. Their jealous feud over the hills ended with Romulus killing his brother.

The city took on Romulus’ name and the patricians of the Roman republic built their statly homes on the mythical birthplace of their city. The plebians were relegated to Aventine.

As I listened to the speakers at the Morningstar Investment Conference last week it was obvious which hill was broadcasting their world view.

The conference is for investment professionals. The patricians of the investment world. And the way the speakers were describing investing differed profoundly from the way I think individuals should invest.

The conference reinforced the simple truth that we the Aventines; the plebs of the investing world; the great unwashed individual investors have all the advantages over the professionals. The problem is too many of us choose to squander it.

The perfect investment

Michael McCorry the Chief Investment Officer of BlackRock in Australia presented during a session titled Alternatives: Why now?.

BlackRock manages $327 billion US in alternatives. Unsurprisingly they believe now is a good time to invest in them.

Alternatives and private markets were a big discussion point during multiple sessions at the conference. The consensus from the speakers was that Australia is behind the US and Europe in bringing less liquid private investments to individual investors. All the speakers viewed that as a bad thing.

I’m not so sure. I understand why the investment industry is pushing private markets. The industry is salivating over the high fees in private markets because we now live in a world where passive investing has driven down fees on public market investments like funds and ETFs.

What do we get in exchange for higher fees and less liquidity? Well the pitch is better risk adjusted returns. Across all manner of private assets including private equity, long-short hedge funds, private credit and venture capital the purported advantage is lower volatility than publicly traded equivalents with similar returns.

This notion of better risk adjusted returns for private assets via lower volatility has become Wall Street propaganda. Everybody says it. Everybody accepts it. Yet too few people question it.

What we should be asking is if this lower volatility is helpful for most investors. We should be asking if low volatility is representative of the actual investments or just the pricing models used to value those investments. The models created by the sowers of the propaganda.

I’ve shared my thoughts on the way private investments are described in this article and this article. No need to rehash my arguments. But central to extoling the virtues of low volatility is the notion that it matters for most investors.

A narrow band of investors should care about voliatlity. Most long-term investors should ignore it. To long-term investors volatility is not risk. The risk is not earning a high enough return to achieve a goal.

The reason that professional investors equate risk with volatility is simple. They don’t know anything about the people investing in the pools of money they manage. This isn’t their fault. It is up to an intermediary like an adviser or you and me to find an investment that fits our circumstances.

But this asymmetry of knowledge gives you and I a huge advantage over professionals. We know what we are trying to accomplish. They don’t.

Understanding the life you want to live and the associated risks to your goals allows you to independently evaluate the self-serving propaganda. Does volatility really matter? Is it worth paying high fees for a benefit most of us don’t need?

The only way to answer these questions is to know what you are trying to accomplish. Far too many investors don’t bother thinking through what they want out of life.

Shackled by size

In a session on multi-asset investing the virtues of private markets were once again extoled. Yet I was far more interested in a statement by Jessica Melville, Head of Portfolio Strategy and Research at AustralianSuper.

She was asked a straightforward and typical question for an investment conference. Jessica was asked if Aussie or international shares were more attractive right now. Her final answer was international shares based on valuation.

But there was a caveat for AustralianSuper. Jessica said, “Partly as a function of our growth, we do need to be exploring a bigger pond and international equities is a broader opportunity set.”

This was not a revelation. It is frequently pointed out the ways size has changed how giant industry super funds invest. AustralianSuper and other industry funds have grown so large that investment decision making is no longer unconstrained.

This applies on multiple levels. The largest driver of returns is asset allocation. As an active manager AustralianSuper should allocate funds to the best available opportunities.

This is a core part of their strategy as they can change the allocation to each asset class within a large band in their pre-mixed option. For example, in the high-growth option at AustralianSuper local shares can make up between 20% and 50% of the portfolio.

Can AustralianSuper and the other industry giants invest where they see the best opportunity? No they can’t. They need to find areas that allow them to invest at scale. Increasingly that is global markets and private investments.

We frequently get the sales pitch of why scale helps the giant super funds. We don’t often hear about how it hurts them from an investment perspective. And the fees we are paying are far too high given their scale.

The ability to invest in whatever you want is a significant advantage for individual investors. It far outweighs the much-touted advantages of scale. Being too big is another structural impediment for professional investors.

The fickle investing mob

One of my favourite sessions from the conference was on Aussie equities. Three fund managers opined on where they saw attractive opportunities in the local market. It was not just their views on individual shares that I thought was more interesting.

Crispin Murray the Head of Equities at Pendal had the following to say about the challenge of investing during volatile markets:

“The challenge for fund managers is to take advantages of that (volatility), as it actually creates more opportunity. We like volatility, we like uncertainty, we have lots of resources, we have lots of contacts with companies so we can take advantage of it. But you also need to manage a portfolio in a way that you don’t get stocked out, you don’t get caught out because the volatility and the correlation in your fund is so great that you get forced to close down or your clients pull the money before you get proven right.”

This quote perfectly ecapsalates another structural impediment that fund managers face. To illustrate those challenges we can compare a professional fund manager to an inconsequential investor - me.

If I buy a share I will be successful if my thesis plays. That isn’t easy. But it is easier than having to be right and have my thesis play out quickly. That is what fund mangers face because they deal with fickle investors who have little patience for even temporary underperformance.

The luxury of patience is a huge advantage for an investor. That is why some of the best professional investors run hedge funds where there are lock-up periods to prevent inpatient investors from pulling money out if there is temporary underperformance. The lucrative fees help as well.

Benjamin Graham appreciated the benefits of patience. His described how Mr Market will constantly present you with prices. But Graham was quick to point out that you have the power of choosing what to do with those offers.

The beauty of being an individual investor is you don’t have to follow the crowd. You can pick and choose when you buy or sell. You are independent. Many professionals don’t have this luxury.

Don’t throw away the gift of being able to take a long-term view. Too many investors squander this away by mimicking professionals and trading too much in reaction to short-term conditions.

Final thoughts

The Palatine was an island floating above the plebian masses of Rome who resided in the malarial valleys and the crowded slopes of Aventine. The Latin word for island is insula. This is the root of the English word insular.

Insular has come to mean not just the physical isolation of an island. The connotation is the intentional isolation from ideas which leads to a narrow-minded view of the world. In an insular world conventional wisdom is never questioned.

I want to be clear that I’ve cherry picked a couple quotes from a long day of presentations. None of these were outrageous statements and most conference attendees probably didn’t notice them.

Why? Because they represent the accepted view of the industry. Even if they are infrequently interrogated. Even if they are not fully understood.

Professional investors are constrained and that shapes the way they approach investing. More importantly, individuals have no constraints.

Scepticism is an underappreciated trait of successful investors. Too many individual investors mindlessly accept the views of the investment industry. Especially the biggest myth of all – that people can’t do this on their own.

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What i’ve been eating

When Christopher Columbus landed on the island of Hispaniola the indigenous people had a unique way to cook meat over indirect heat. The intrigued Spanish named this cooking style barbacoa. Eventually migrating to the US, BBQ is an obsession in the south and there are countless arguments over different styles. While the types of meats and sauces vary across regions the cooking technique is the same – low and slow indirect cooking over smoke. I’ve been disappointed by most attempts at BBQ in Australia but I was in the Mornington over the weekend and Red Gum BBQ had some great brisket, sausage and Mac & Cheese.