Active investing – the uncomfortable truths
Mark Cliff, Marketing Manager at PSG Asset Management.
The only way in which fund managers can deliver superior performance versus a benchmark or its peers is to assemble a portfolio that is different. The size of the opportunity to outperform will be determined by the degree to which the funds are different.
Some investors are happy to be invested passively, to sit in the relative comfort of the herd and/or hug the benchmark, will have a high probability of achieving average performance and will have little risk of falling far short of it. On the other hand, if your definition of success is superior performance, then you’ll have to make peace with some uncomfortable truths in order to achieve success.
A manager is required to assemble a portfolio that is different from most others to get a different outcome from the herd. How different will determine how far performance will differ. There is no way to strive for the former without bearing the risk of incurring the latter.
While most people appreciate that superior performance requires contrarian decision-making, many investors find it very difficult to stomach the discomfort that accompanies a portfolio that looks different and is prone to underperform over shorter time periods. It is well known that people experience the fear of a loss much more acutely than the anticipation of a gain. In this environment it is very difficult to hold the line when your portfolio is underperforming and the herd is frolicking in the opposite direction.
Investors also have to accept the risk of making mistakes. No cricketer scores a century every time they bat and even arguably the greatest batsman of all time can get a duck. Skilled managers will make fewer mistakes than their peers and will aim to expose their investors to an asymmetry of risk – where the probability of a gain is higher than the probability of a loss. Even so, they will make mistakes and these mistakes will lead to losses. The investor who seeks superior performance will have to accept the inevitability of this fact.
Are you willing to be patient?
Most great investments begin in discomfort. Investments that look certain have generated predictable short-term returns and provided investors with that warm fuzzy feeling but are rarely available at bargain prices. Bargains are usually found in places of pessimism, are shrouded in controversy and usually have a poor short-term track record. Bargains are unloved and feared. It is hard to buy these investments but it is usually the discomfort of doing so that has caused the mispricing and thus provides the opportunity. Decisions that turn out in time to be correct are unlikely to do so promptly as future events are uncertain and the timing of these events, while sometimes inevitable, is particularly variable. At the time, what is different may also just appear to be wrong.
Investors are often required to be patient in order for the passage of time to allow the mispricing to resolve and to reap the rewards of these uncomfortable decisions. This can take a relatively long time and requires the investor to stand by their convictions and always consider the long term.
This approach works
Superior fund managers want to deliver great performance to investors. They know that to do so they have to assemble portfolios that are different to that of the market. The portfolios they manage will, over time, look and be different to the market. Often their decisions mean buying stocks that are unloved and it will almost inevitably take some time before investors start to reap the benefits of these calls. The patient investor is usually rewarded with superior returns.
