Financial marketers know that human wiring encourages us to judge decision-making skill based on the recent outcome. This is true even if that outcome is a random result. So in the investment world, tossing a coin and producing heads three times in a row is seen as skillful. Predicting the wrong result of a toss is viewed as a repeatable and flawed approach, and this is true even though the probabilities for the next toss remain unchanged. My take is that it is much easier to focus on short term results than to try and uncover whether-or-not an approach is increasing the probability of success for a significant period of investment results. Counting and sorting random results has the illusion of a scientific method. It can also encourage manipulation of meaningless periods of data so as to infer skillful management and decision-making. It opens the door to manipulation by inference.
Unfortunately, from a purely statistical basis it takes about 30 years of data to make a confident assessment of skill for investment management. The evidence of “beating the street” simply cannot be identified in one, three and five year tables. For practitioners, this presents a big problem as 30 years is an investment lifetime. Also, the skillful manager is generally about to retire once you have confidently identified his or her ability. It would be much more convenient if we could confidently identify future out-performance. Unfortunately, there is always uncertainty. If we knew the outcome, returns on stocks would be equal to returns on bonds.
In my opinion, the time and effort to identify a hot hand is better spent on good portfolio construction. Good financial advisors have processes that generally guide clients towards strategies designed to minimize errors of judgement. They focus on cost control. They provide guidance around matching fixed income from your portfolio to income you require from the accounts in retirement. Good advice often encourages investors to patiently allow stock market return to be realised by the portfolio in a consistent repeatable approach. There is generally much less of a focus on market timing. They recognise that the recent past offers little in the way of predictive power.
In our practice we focus on repeatable investment success. Our portfolio approach has been refined through more than thirty years of combined, on the job, experience. If we are already working with you great – if not, let’s meet to see if we can be of service.
Patrick
