Ninety percent of what passes for brilliance, or incompetence, in investing is the ebb and flow of investment style (i.e., growth, value, foreign vs. domestic, etc.). Since opportunities by style regress, past performance tends to be negatively correlated with future relative performance. Therefore, managers are often harder to pick than stocks. Clients have to choose between fact (past performance) and the conflicting marketing claims of various managers. As sensible businessmen, clients usually feel they have to go with the past facts. They therefore rotate into previously strong styles, which regress [to the mean], dooming most active clients to failure.—-Jeremy Grantham
This is a pretty long quote, but it’s a gem I found sandwiched into an Advisor Perspectives commentary by Jeffrey Saut. (I commend Mr. Saut for having the perspicacity to throw the quote out there in the first place.)
Mr. Grantham not only has a way with words—he has a valid point in every single sentence. That paragraph pretty much sums up everything that goes wrong for clients.
It’s also true from the standpoint of an investment manager. Our investment style constantly exposes clients to high relative strength stocks or asset classes. Some quarters they perceive us to be brilliant; other quarters, not so much! In reality, we are doing exactly the same thing all the time. Clients are actually reacting to the ebb and flow of investment style, as Mr. Grantham puts it, rather than to anything different we are doing.
The ebb and flow of investment style takes place over a fairly long cycle, often three to five years—in other words, usually an entire business cycle. During the flow period, clients are very excited by good performance and seem quite confident that it will never end. During the ebb period, it’s easy to become discouraged and to become convinced that somehow the investment process is “broken.” Clients become confident that performance will never improve! Grantham’s observation about the when and why of clients changing managers corresponds exactly with DALBAR’s reported poor investor performance and average 3-year holding periods.
Patience and the acknowledgment of ebb and flow would go a long way toward improving investor performance.
Is the ocean broken, or does it just ebb and flow?
Source: Eve Sob blogspot
