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Showing posts with label Unconventional Behavior. Show all posts
Showing posts with label Unconventional Behavior. Show all posts

April 13, 2014

Dare to be Different – Behave/Invest Unconventionally


In investment world, the experts are convinced that a portfolio needs to be diversified especially when you are managing public money. It is better to follow conventional behavior rather than to feel sorry later which may have many repercussions like compensation cuts, job loss, embarrassment, unpleasant headlines et cetera. However, when you set a path where you dare to be different rather than a part of the herd, you are supposed to take a different route with Unconventional Behavior for Favorable Outcomes.

Howard Marks, one of the World’s most renowned Portfolio Manager and Chairman of Oaktree Clients portrays a similar story in his latest memo, “Dare to Be Great II” (the first memo on “Dare to Be Great”, he had written in mid 2006). He says if you want to be an outstanding wealth creator, you need to be different with different outset. In his words,

“The real question is whether you dare to do things that are necessary in order to be great. Are you willing to be different, and are you willing to be wrong? In order to have a chance at great results, you have to be open to being both.”

He says that an investor can’t take the same actions as everyone else and expects to outperform. It ought to be different – you have to assemble a portfolio that is different from those held by most other investors.

He suggested a two-by-two matrix along with a rationale.

 
“Only if your behavior is unconventional is your performance likely to be unconventional…and only if your judgments are superior is your performance likely to be above average”

For those who define investment success as being “average or better,” three of the four cells of the matrix represent satisfactory outcomes. But if you define success strictly as being superior, only one of the four will do, and it requires unconventional behavior.

So, what needs to be done to act different? He says, 1) being active in unusual market niches, 2) buying things other haven’t found, 3) don’t like or consider too risky to touch, 4) avoiding market darlings that the crowd thinks can’t lose, 5) engaging in contrarian cycle timing, and 6) concentrating heavily in a small number of things you think will deliver exceptional performance.

Noted but they look nice on paper…

Few points mentioned above may not be applicable in many developed countries as the efficient markets hypothesis comes into picture and there is hardly any known arbitrage. However, in India, where the equity market has still not found its depth despite many years of its existence provides the perfect place to replicate all unconventional behavior. The word of caution is for investors who are not willing to take risks and are happy to take home an average return. But for investor or portfolio manager or those who has some sense in financial market can play different to get above-average results with favorable outcomes.

Is it easy to be different?

Howard quotes from Pioneering Portfolio Management by David Swensen of Yale (also my favorite Asset Allocator; you can listen his one of his lecture on Portfolio Management and Asset Allocation)

“Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom”

Non-consensus ideas need to be alone, if you want to achieve above average results.

For kissing success, you need to witness a fail

If you are on a path where you have not tasted any defeats or have not committed any mistakes, then you may not get extraordinary results. You have to give yourself a chance to fail; learn from your mistakes.

The above matrix says that since the conventional behavior is sure to produce average performance, people who want to be above average can’t expect to get there by engaging in conventional behavior. Their behavior has to be different. And in the course of trying to be different and better, they have to bear the risk of being different and worse. Superior skills can increase the expected benefit from concentration and leverage.

He further states that superior investment results can only stem from a better-than-average ability to figure out when risk-taking will lead to fain and when it will end in loss. There is no alternative.

Dare to Look Wrong

He states, “This is really the bottom-line: not whether you dare to be different or to be wrong, but whether you dare to look wrong.” In order to get results, investment manager accept that they will make mistakes to make correct investment decisions. However, the real challenge is few people expect to find a lot of sure things or achieve a perfect batting average.

In a nutshell, we have to believe that you need to behave differently with unconventional behavior to achieve above average results. Unconventional behavior is the only road to superior investment results, but it isn’t for everyone. In addition to superior skill, successful investing requires the ability to look wrong for a while and survive some mistakes.

Rightly said, it isn’t for weak heart investors who can’t see losses.