Puncturing fund management myths

Where investment management and the media meet, a number of myths have sprung up that have now become accepted wisdom. But in reality there are no simple formulas for success.

The investment management industry ought to have nothing in common with the world of media. Successful investment management is about generating consistent long-term returns from stable strategies and styles. The media is a world of constant change, requiring news, stories, drama and crises. However, inevitably, the world of finance wants publicity, and the making or losing of money is a popular source of stories for the media.

The result is the financial entertainment industry, fed on a stream of topical nostrums and instant interpretations of events. In this world, sweeping statements, often originating as little more than a plausible sound-bite, are rapidly disseminated and converted into the accepted wisdom. The list of these is a long one, but the following are a few of my favourites.

“We are in a world of lower returns than in the past.” From 1980 to about 1995, this claim was heard regularly, and equally regularly turned out to be wrong. In the late 1990s, the opposite view, that returns would stay high, came to be accepted, and was equally wrong. Why should this view be right now, when the global market rating is at its lowest for 20 years?

“Economic outcomes are the driving force of equity markets.” If this were true, European markets would have performed dreadfully, and the Chinese market superbly, in the last two years. Economic growth creates an environment in which it is easier for companies to grow profits, but the main driver of markets is the action taken by companies to raise returns.

“Corporate profitability is at a long-term peak.” Profitability is high, having been on an upward trend for nearly 15 years, but there is no reason why it cannot go higher, so long as companies are striving to improve returns to shareholders in an oligopolistic world.

“Global asset allocation should be based on geography.” Globalisation has made the nationality of many companies an accident of history or a flag of convenience. The UK’s FTSE 100 index contains five mining companies, but not one of them has a mine in Britain. The importance of geography is in steady long-term decline in a world moving inexorably toward global stockpicking.

“Market timing is a futile occupation: stock selection is the only way to generate superior performance.” The hunt for alpha is becoming ever more competitive and difficult, and to conduct it without some view of the direction of the market is like trying to drive in thick fog. Market timing can add significant value, and investment returns are not so easy to generate that it can be ignored. However, just as top-down analysis is helpful in the identification of favoured themes and sectors, it is hard to attempt without knowledge of the underlying stocks.

“There is no relationship between bond and equity markets.” Until 2000, the existence of a strong relationship between bond and equity markets was universally accepted. Since then, it has been widely discredited. Yet any valuation of equities requires the use of a discount rate, invariably based on the risk-free rate of the yield on government bonds, and a comparison with competing returns. The relationship has been shown not to be simple, but that does not mean it can be ignored.

These theories are partially true, but the financial entertainment industry does not want caveats, qualifications or complexity. It wants simple short statements, straightforward conclusions and originality, because unconventional thinking is of course so much more interesting than the opinions of the herd. This has led to the popularity of claiming to be a “contrarian.”

Unfortunately, it is impossible to have more than a small number of contrarians. The dilemma was perfectly illustrated in the “Battle of Britain” sketch in Beyond the Fringe. “Please, Sir,” says the aspiring fighter pilot, “I want to join the Few.” “I am sorry,” he is told, “there are far too many.”

In reality, there are few genuine contrarians, and for them it is a way of thinking which is natural and instinctive. It cannot be learned. Most wannabe contrarians are conventional thinkers who deliberately misrepresent the views of others in order to make their own views sound different.

It is only natural that the participants in the dull old business of investment want to make their work appear more exciting and their opinions more interesting than they really are. In the current climate, the most insignificant ripple of news is exaggerated into a tidal wave, and the most orthodox of views are passed off as deeply profound. Life in the industry was much duller and financial services provided far less employment in decades gone past.

The financial world is much more fun these days, and, as Andy Warhol observed, “everyone can be famous for 15 minutes,” but when it comes to producing satisfactory investment returns, there are no easy answers and no simple formulas for success.