Finding the Limitations in Your Investment Process

I attended a conference recently where one of the speakers was the head portfolio manager of legendary investor George Soros’s family office. This guy was good. He touched on nearly every hot button issue in the markets and the the economy.

After giving his take on the state of the markets and where he was seeing value, the gentleman who was conducting the interview on stage gave this PM a lightning round of questions.

• Will Greece still be in the EU by this time next year?
• Where will 10 year interest rates end the year?
• Will GDP growth pick up in the second half of the year?
• Gold prices: higher or lower?
• Is Silicon Valley in a bubble?
• Will kind of returns will we see on the stock market this year?
• What’s the best country to invest in right now?

I could go on because there were many more of these types of questions, but the impressive thing is that this guy had an answer for every single one of them. He didn’t skip a beat or stop to think about any of the questions or implications. Every answer was articulate and well-reasoned. Everyone in the room (myself included) was hanging on his every answer because he sounded so sure of himself. Each prediction sounded like it was a lock to come true.

After digesting an hour long talk with rapid-fire market predictions, I realized he didn’t answer one question with “I don’t know” or “That’s not really in our wheelhouse” or “Your guess is as good as mine.” Everything seemed a little too easy and there were no holes in this guy’s pitch. To be clear, this was just an interview for a conference and I’m sure he doesn’t base his entire process on making these types of market calls.

He was probably humoring the audience.

After listening to these types of speeches I always have to remind myself that some people have the ability to make it look easier than it really is. You have to remember how important it is to admit your own limitations. When looking into any investment strategy, portfolio manager, advisor or fund offering I find it’s a red flag when someone doesn’t come out and admit the weaknesses in their investment process.

I understand why firms like to avoid this kind of transparency. It’s not always a great sales tactic to talk about where things can go wrong. But when trying to establish long-lasting client relationships, as most financial firms should be trying to do, being open and honest up front is how you set the correct expectations going forward so no one’s surprised by future developments.

Unfortunately, I’ve seen far too many professional investors who would rather make the initial sale than tell the truth to prospective clients. When things do take a turn for the worse, and they always do at some point, the strategy shifts to the blame game and it’s time to come up with excuses. This is a terrible way to run a successful business, yet so many financial firms do things this way because certainty and overconfidence help close the deal.

No strategy is built for every eventuality. No advisor or consultant can keep your portfolio out of harm’s way at all times. No portfolio manager was born without cognitive biases. Spend enough time convincing others that your process is without flaws and you could start to believe it yourself.

If you’re looking to work with someone in the investment business you could do much worse than looking for people or organizations who:

• Learn from their mistakes.
• Work hard to systematically reduce or eliminate the effects of behavioral biases on their decisions.
• Are willing to say “I don’t know” from time to time.
• Set realistic expectations.
• Are completely transparent with their process, including potential weaknesses or limitations.
• Do what they say they’re going to do.

I’ve discovered over the years that it’s always easier for investors to poke holes in other investors’ strategies, but rarely do they do the same with their own process. For some reason many believe they need to project a master of the universe quality at all times. And I understand why this is the case — most people don’t settle on a philosophy they don’t believe in.

But I find it refreshing when someone is willing to admit that the markets are hard, regardless of how they choose to invest in them. Admitting this fact is one of the first steps towards becoming a better investor.

Further Reading:
The Value of I Don’t Know
Observations on the Investment Process
Why It’s So Hard to Change Your Mind About the Markets