Dylan Grice, strategist at Soc Gen, is one of my favourite out-of-the box thinkers and his regular piece “Popular Delusions” is always a thought provoking and enjoyable read. His latest missive is a farewell note (he is leaving Soc Gen to join a hedge fund) and provides important insights into investment management , written in his inimitable humorous style. To summarise:
-Successful investing is about survival – and in this respect there are few creatures which can top the lowly cockroach.
-Cockroaches have been around for 350 million years, appearing after the second of the earth’s five mass extinctions, with the last one wiping out the dinosaurs.
-Cockroaches follow a simple and robust method of survival – by moving in the opposite direction to gusts of wind which might signal an approaching predator.
-Their approach to survival has significant relevance to investing – it isn’t necessarily about being clever or devising optimal strategies – it’s about having a simple method to thrive.
-When he started work in 1997, the only place to be was equities as this was the era of the tech bubble and the book “Dow 36,000”.
- Pension funds and insurance companies had upto 85% of their assets in equities, which had outperformed bonds without much higher risk – the maximum real peak-to-trough decline (“drawdown”) for equities was 17% (1990) and for bonds it was 13% (1994 –see chart below).
-Moving a decade later to today, we face a similar environment with institutional investors having replaced most of their equity holdings with bonds, with equities suffering two 50% drawdowns over the course of the decade while bonds holding firm (maximum 10% drawdown) and actually outperforming equities (see chart below).
-Owning equities in the 1990s and bonds in 2000s would have been the optimal strategy – but switching at the right time is an elusive strategy for most investors. A lowly cockroach approach, by accepting that they are not clever enough to time the market correctly, would have served investors better by being equally weighted in equities and bonds.
-This strategy would have performed relatively well since 1990 with equity type returns but significantly smaller drawdowns (maximum of 20%) as the two charts below illustrate:
-However, going back to the 1970s the simple 50 equity/50 bond strategy would not have performed well under an inflationary scenario with a maximum real drawdown of 38%, compared to equities (52%) and bonds (46%).
-A real cockroach portfolio in that environment would have been to be resistant to inflation, deflation , credit inflation and credit deflation without entailing a view on the market, resulting in a portfolio equally weighted between real assets (25% gold, 25% equities) and nominal assets (25% cash, 25% bonds).
-This portfolio would have had significantly lower risk (maximum drawdown of 22%) with a comparable real annual return of 5%, to equities (5.5%) and bonds (4%) since 1971 (see two charts below).
-In 1975, the legendary investor Charles Ellis wrote about investment being a “loser’s game” – making the point that the ultimate winner of this loser’s game is the one who loses the least points. This is analogous to tennis, where the professionals win points by going for winning shots while amateurs lose them by also trying to go for winning shots rather than avoiding mistakes.
-Perhaps we spend way too much time trying to be clever and predict the market and future events – while it may be better to focus on keeping it simple and not making dumb mistakes.
Wonderful advice and it would pay to try and implement it in our investment activities - investing is not about appearing clever, sounding erudite or winning intellectual arguments at gatherings but about surviving over the long haul and earning an appropriate return for the risk taken. Based on my readings of the investment greats over the years, there are five guiding principles which I try (but often fail!) to apply:
1.Keep it simple (i.e. be cockroach like!).
2. Diversify (because you don’t really know the future and it helps you avoid making fatal mistakes-no one does this better than Ray Dalio).
3.Be a contrarian, armed with a calculator (because that is when you usually get paid for taking risk-this gem is from Seth Klarman).
4.Be patient (because it’s the only advantage an individual investor has over the institutions, and if only implemented, would allow him or her to beat 99% of institutions over the medium to long-run-this one is a gem from Jeremy Grantham!).
5. Be disciplined (to implement the above four points religiously-daily practice here in all aspects of life helps enormously!).
There is another overall guiding principle I did not include in the list above, as it pertains more to life rather than to merely investing (as do points 4 & 5!)-the importance of humility. In that context, I provide a recent quote below by the well-known fund manager Mark Mobius about his mentor, the legendary investor John Templeton on the occasion of his 100th birthday celebrations:
“I learned many things from the late Sir John, but I think the most important was humility. He always said that we have to be humble, because without humility we won’t be able to learn and adapt to changing environments. And he didn’t just talk about those things, he really led by example. That’s something I try to emulate in my own life.”
Good luck to successful investing over the long run!
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