← Many Happy Returns
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- [00:01]
A
Today's episode is sponsored by Trading 212 the platform bringing commission free investing to everyone. Welcome to many Happy returns where we aim to make you a better investor. I'm Roman.
- [00:14]
B
And I'm Michael.
- [00:16]
A
The best investors aren't necessarily the cleverest, the best paid or the most daring. In fact, evidence suggests they're closer to the opposite. We look at the surprising backgrounds and temperaments that may outperform.
- [00:30]
B
I want to know what actually predicts investing success and can you cultivate it? And in today's Dumb question of the week, are cats better stock pickers than fund managers? Okay, let's get into it. So over the weekend, Romin, I dug into a lot of research on different traits and different professions and different personalities and how that relates to whether you're a good investor or not. And to summarize it up top, I think the perfect investor seems to be a working class, minivan driving, poker playing Finnish woman who never logs into her account. Do we need to say any more?
- [01:10]
A
I don't think I qualify on many of those accounts, do I? I think my cards are marked now.
- [01:15]
B
But before we go on, we should caveat this whole thing by saying a lot of these studies we're going to reference in passing are based on very small sample sizes and would probably drown in the replication crisis that has swept across academia. But Romin, they confirm so many of our biases that I think it's great research. But let's go on to the first big question here. Does intelligence help? Are cleverer people better investors?
- [01:43]
A
The way I've always seen it is that if you are too clever, then it can be a hindrance because you overthink things. And I speak to lots of people who've just delayed an investment because they're scared about this and that because they do understand the world and they do want to try and apply that to their investments. And there are always lots of reasons to be scared. In fact, you're a great example of this because you read around all of the subjects that we talk about and you kind of get into topics. I can feel that just chatting with you. For example, when we were doing AI, you were quite scared by some of the prospective changes that would come with AI.
- [02:21]
B
It doesn't stop me handing anthropic £90amonth though, does it?
- [02:28]
A
But do you think that's true? Do you think that it kind of scares us when we read about a topic and we think, oh, well, you know, it's all going to end, it's all finished, you know, I'm not going to invest anymore. Or do you think we get drawn into a narrative and go too far down a rabbit hole?
- [02:44]
B
I think the evidence certainly suggests that when you're investing you want to be in the mode of making slow decisions. If you think about system one decisions, when they're gut instincts and fast reactions, that's generally a problem when it comes to investing. Whereas if you take those kind of rational, considered decisions, that's likely to help you. Because the main thing in long term investing is avoiding making catastrophic mistakes. You can have one bad year which can ruin 30 years of compounding. Now, if you look at the evidence around intelligence, I would probably summarize it like this. Intelligence does help, but it helps by avoiding those self inflicted errors, not through a kind of genius stock selection. It's your ability to override that gut reaction.
- [03:32]
A
So let's start off with a Finnish paper which is about IQ and stock market participation. Now, in case you're not aware, in Finland they have a draft. So everybody of a certain age, who's male, I think, think has to go into the army. And as part of that process they measure their iq. So it is a nice test case about whether intelligence affects how good you are at investing. And what they found was that participation in investment rises steadily as IQ increases. And that's true whether you're wealthy or not. And also that high IQ individuals hold more equities, they diversify more, they have less risk, and that means their risk adjusted return, so return to divided by risk is higher. So so far it seems as if intelligence is a good thing.
- [04:24]
B
Few. And there was a follow on paper around that same finished data set which had other interesting findings about how IQ relates to investing performance. And it found that higher IQ individuals show less of the disposition effect. This is that phenomenon where investors notoriously sell their winners too early and hold onto their losers for too long. Apparently intelligent people were less likely to do that. They were also better at using tax loss harvesting, partially I think, because they're more willing to sell their losers. And there is some evidence that higher intelligence meant you were more likely to succeed at market timing and stock picking, though we know that's probably a fool's errand for most people, regardless of how smart you are.
- [05:10]
A
But this isn't about absolute returns, this is about being better than other people. So even if they're just under 5 percentage points a year better than the average, that doesn't necessarily mean they're great at generating lots and lots of excess return relative to an index investor.
- [05:27]
B
Yeah, Otherwise we just all hand our money to some genius and we'd all get rich. It doesn't work like that.
- [05:33]
A
I remember when I had a stint in the experimental psychology department at Oxford when I was studying cognitive science, there was a guy who was an expert on theory of mind. And the idea is that you've got an understanding of what thinking is and you can see that in other people and adjust your behavior because you can model what other people are thinking. But I think what's also useful is that reflective skill and you can understand how you're thinking and adjust your behavior based on your own shortcomings. And there was a working paper called what Makes a Good Trader? On the Role of Intuition and Reflection, which was about this, and it was about overriding this fast system. One thinking where you just react to information very quickly, maybe emotionally, and you apply this theory of mind. People often say that investment isn't about working out what's good or bad, it's working out what other people think is good or bad. So it's kind of second level thinking there.
- [06:32]
B
And that paper would kind of suggest that it's not really IQ itself that matters. Like raw intelligence, it. It's the ability to be reflective and to understand other participants in markets and how you can benefit from that cognitive reflection.
- [06:47]
A
I love that phrase. I haven't come across that before, but
- [06:50]
B
I think it's one of those supposed findings, Ramin, that confirms our priors. So we go, yeah, that's probably right. Let's just say that on air. But I was a little skeptical of all these papers. That one you just mentioned, for example, is based on lab testing, really? Not live trading. So whether it applies in the real world, who knows? It would seem to make sense, though. Rash decisions rarely benefit you in markets. There was also a paper that looked at whether older people make better investment decisions.
- [07:21]
A
No, I definitely think that's true.
- [07:23]
B
Oh yeah. Well, I've got some good news and some bad news for you. It seems that older investors do apply better rules of thumb to their investments. They're better diversified, they make less trades, they do more optimal tax loss harvesting, but yet they show worse skill overall. And there's a paper, do older investors make Better Investment decisions? Which argues that even though they have learned from experience to some extent, the cognitive decline that they experience swamps that effect. And overall, the older cohort experienced around 3% lower risk adjusted returns.
- [08:03]
A
Uh oh, well, you've known me for a while now, so you must have witnessed that cognitive decline in action. What could you say about it?
- [08:10]
B
Just got to script everything these days, haven't we? That's what it comes down to.
- [08:17]
A
Well, I think that script point is a good one. And a lot of the pension crafters say that having a simple portfolio, keeping things, you know, really quite tidy and neat instead of these huge sprawling portfolios that require a lot of maintenance, that really helps. And I think that's probably true as you get older. You don't want something which is complex, which has a lot of management in it. I've certainly found that to be true myself. I want to simplify my life as I get older. In many ways I think people do
- [08:49]
B
worry about am I going to be able to manage my finances as I get into my 70s, 80s, 90s. It's hard to keep on top of how everything changes and remember to do the right things.
- [09:01]
A
Plus I think you get to the point where you just don't care. You just think, well okay, it's going to make 5% difference, but I'm not going to be around that long and I don't care. Whereas I think when you're in your 30s, you probably think much more about perfection. You know, will I get this right or wrong and it's going to affect me down the road. When you reach 70, 80, well you don't really think that's important anymore.
- [09:24]
B
I mean the instinct some people have as they age, I guess, is to hand everything over to a professional and let them worry about it for you. But I think the evidence here is that it very much depends what kind of professional you're talking about. Are you talking about fund managers or are you talking about financial advisors? So let's start with the first one. As we've said many times before, the evidence is very, very strong. The active managers underperform the broad market.
- [09:52]
A
Yeah. So the SPIVA result about global index funds denominated in sterling, over 90% of them underperform the passive benchmark over a 10 year period. Which is atrocious statistics.
- [10:07]
B
And it's not just a UK phenomenon. The SPIVA report shows that effect across basically every country in the world and every asset class.
- [10:16]
A
Yeah. Whether it's fixed income, whether it's equity, whether it's a bull market, whether it's a bear market, it's a really strong statistical result.
- [10:25]
B
So professional fund managers, maybe they don't earn their fees. Let's look at financial advisors now again here it's a bit of a complex picture. So if we're talking about the financial advisors who are actively managing their clients portfolios, again the evidence shows clearly that they do worse than the passive benchmarks, especially after fees and commission. And there's an interesting study called the Misguided Beliefs of financial advisors from 2021, which looked at Canadian advisers. And what was interesting about this study is that it showed the way those advisors manage their own money and their own portfolios is basically the same as the way they manage their clients. And they underperform as well by around 3% per year, either by picking the wrong funds or picking the wrong stocks or trading at the wrong time. All of these things that we know hurt your performance. And that paper is quite clear that the common view that people have of retail financial advice is that the conflict of interest that the advisors have contributes to the high cost of advice and the underperformance. But this paper says not really, no, because the advisors are doing the same thing with their own money. It's not that they're scamming you somehow. It's that they have mistaken beliefs and are kind of bad at their jobs, if you want to put it in that way. And the sort of cherry on top in that paper is that it shows that the advisors, even after they've left the financial industry, continue to make those same mistakes with their own portfolio.
- [11:53]
A
What people often say to me is, here's my portfolio, which my advisor has been managing and is horrendously underperformed. Is it because they're getting some backhanders off these fund managers? Is that why they've chosen these funds? And I can't believe that's true. And this evidence certainly suggests it's not true. They're genuinely bad at their jobs and also bad at managing their own money. Now, the value that they might have, and we touched on this earlier when we were talking about people with declining mental faculties, is that they stop stress. And I spoke to someone at Vanguard recently who said that there was recent research which showed exactly that, that the biggest benefit of having an advisor is that you just spend less time thinking about your portfolio and stressing about. So if that does reduce your stress, maybe it's justified, maybe the fee's justified.
- [12:45]
B
Interesting, because I did come across a paper from Vanguard in 2022. I wonder if that's what they were referring to. The result wasn't so much about reduced stress, but it was that financial advice does have a positive effect on returns by stopping clients making the big mistake, which is panic selling in a crash. And I think their estimates were that good advice can add something like 3% per year of returns compared to the counterfactual where that client is managing their own money and making their big mistakes. And the single biggest component of that positive benefit is the coaching element, which might add up to 1.5% per year. Obviously Vanguard has an incentive to find that result, but as someone yourself who does financial coaching, you must think it has some value.
- [13:34]
A
Oh, definitely. I mean, if it is someone that's not going to be able to manage their own money, if they are someone who panics and sells, then it makes absolute sense to have an advisor between them and their money to avoid them selling after a crash or taking too much risk, or not diversifying enough or not taking enough risk. All of these nudge points would be useful for an advisor to steer someone in the right direction, although being part of an investment community probably would also steer you in the right direction. Today's episode is sponsored by Trading212, the platform bringing commission free investing to everyone. Trading 212 stocks and shares ISA is the cheapest way to invest with 0 commission and one of the lowest FX fees I could find on the market. Looking to keep things simple, you could easily automate your investing with PIs that allow you to rebalance your portfolio at the click of a button. Customers with Invest accounts can also benefit from the Trading212 card which has no FX fees and true interbank rates. Many happy returns listeners can claim free fractional shares worth up to £100. Just create and verify a Trading 212 invest or stocks IsaAccount. Make a minimum deposit of £1 and use the promo code RAMIN within 10 days of signing up or use the link in the show notes. When investing, your capital is at risk and you may get back less than invested. Past performance doesn't guarantee future results. Pyzon Auto Invest is an execution only service, not investment advice or portfolio management. Automatic investing refers to executing scheduled deposits. You're responsible for all investment and rebalancing decisions. Free shares can be fractional. 212 cards are issued by Paynetics, which provide all payment services. Trading212 provides customer support and user interface. Terms and fees apply
- [15:35]
B
okay, so it seems that we've said having some brains helps a little bit. Maybe, but not in the way you might expect. And having some credentials might help a little bit, but both of those things are just about stopping you making the big mistakes. Let's drill down further and see what makes an investing winner versus a loser. What's the kind of biggest sin?
- [15:58]
A
I think the big one is overconfidence and what happens when you're Overconfident, which is that you over trade. And this is why I've crafted my entire portfolio and my investing system to try and stop me doing that.
- [16:11]
B
And I think that is a very robust finding which you see across all kinds of academic papers. For example, trading is hazardous to your wealth. A seminal paper from the year 2000, which looked at around 66,000American households in the five years up to 1996. So it's a bit dated now, but I suspect the result still applies, which is the active traders earned around 11% per year, which underperformed the markets, delivering around 18% a year. And they found that overconfidence is what drives that churn in portfolios. And the churn destroys your returns.
- [16:48]
A
But can you believe the turnover of 75%? I mean, that's incredible. I hardly touch my core.
- [16:57]
B
So is that saying that at the end of the year, only 25% of the original portfolio is still there?
- [17:03]
A
I believe so. I believe so, yeah.
- [17:06]
B
That is a hell of a lot.
- [17:07]
A
But look, if you do single stock trading, maybe that's the way they operate. And I think nowadays, 25 years down the line, it's likely to be even higher that turnover because we've now got these platforms which make it so easy to trade. There's just almost no friction. Trading costs have come down, you've got an app, you can use it 24, 7. Plus there's all this buzz about things like iPodOS, tech, AI, which is all trying to make you trade more, I think.
- [17:36]
B
Yeah, I don't think our audience is going to find that result controversial, though, are they? We tend to attract the boring, passive investors and we love them. We are that ourselves. But I wonder if this finding will raise a few eyebrows. And again, it seems to be pretty robust over many different papers, is that female investors invariably outperform men on average. So, for example, there's a paper from 2001, boys will be boys, gender, overconfidence and common stock investment.
- [18:11]
A
Now, presumably this is because of a link between gender and your overconfidence. So if you're male, you're more likely to be overconfident and more likely to trade more. Is that the linkage here?
- [18:22]
B
Yeah, I don't think it's anything to do with our chromosomes. I think it's just that, yeah, we're more likely to make rash decisions or whatever. That result seems to be found in a lot of different areas of psychology. Maybe it's for cultural reasons, maybe it's for evolutionary reasons, some combination, who knows? But that Study looked at around 35,000 households, found that men trade 45% more than women and that trading cut men's returns by 2.6 percentage points per year, whereas women experience the same effect to only 1.7 percentage points per year.
- [18:58]
A
But it's odd, isn't it? If you look at pension sizes in the uk, for example, there's a massive pensions gap between men and women. So is that just about the amount that people have saved over the course of their lifetimes? It's not about their trading ability?
- [19:12]
B
Yeah, I think that's the key thing. There's a difference here. The research is looking at men who invest and women who invest, and the women who invest outperform the men who invest. However, fewer women invest as a percentage of the population. Do you see what I mean? So the balance overall will mean men are getting richer.
- [19:31]
A
Now, thankfully, the next one is not a Finnish study. So finally, I think it was based in the uk, it was done by Warwick Business School at least. But this looked at 2,800 Barclays investors over a three year period. And what they found was that the women outperform men by a whacking 1.8 percentage points. And that was largely because they traded less nine times a year versus 13 for the men. And they avoided lottery stocks. So if you're not aware of this, lottery stocks are the ones where you've got a potentially huge payoff. It might be an ipo, it might be some kind of meme stock where you've got a very low probability but potentially high payoff. That's what we call a lottery ticket. Whereas the boring plodders, the index funds, those are what usually tend to do better. And this was also backed up with data from Fidelity, which track 5 million accounts and showed a smaller 0.4 percentage point edge by women over men over a period of a decade. So pretty robust results in large numbers.
- [20:38]
B
Yeah. The magnitude of the effect seems to vary by studying, but whichever way you look at it, it seems that women are doing better when they invest. But Romin, I feel that we've moved away from Finland for a little bit too long. Let's go back to Finland again. So, sensation seeking, overconfidence and trading activity paid from 2009. These clever boffins combined investor tax returns with driving records and psychological profiles. And what they found was that sensation seekers, which was proxied by speeding tickets, was correlated with being overconfident and over trading. And the interesting thing here is that they controlled for lots of variables, so they controlled for wealth for income, for age, for the size of your portfolio, marital status, occupation. So they tried to take all that off the table and they found that still people who drive faster trade more and perform worse in the stock market, which I kind of love as a result.
- [21:41]
A
So if you drive more slowly, does that mean you'll get better portfolio returns?
- [21:46]
B
Well, I don't want to go down the causation correlation route, but it seems that people who drive more slowly make better, more considered, more disciplined investment decisions. I guess maybe that's over reading the paper, but that's the kind of direction it's going in.
- [22:00]
A
Well, you're more likely to survive to old age and enjoy those long term returns. So maybe there's that aspect of it.
- [22:06]
B
I think it's more of a personality trait thing. If you're a sensation seeker, then I guess you're more open to gambling. You like that thrill, that feeling of taking a risk.
- [22:17]
A
And gambling is a good way of describing it. I always say that investing shouldn't be exciting. If it is, you're doing it wrong. And there is some evidence to suggest. There's a paper called who Gambles in the Stock Market? Which looked at state lottery players and correlated that with people who buy lottery type stocks. And generally the profiles did match. So it tended to be poorer, younger, less educated males who bought these lottery type stocks.
- [22:46]
B
As in they're overrepresented in the data versus the population average.
- [22:51]
A
Yeah, yeah, yeah.
- [22:52]
B
Now obviously when you're doing any of these studies looking at the gambling in the stock market, you have to make an assumption about what is a lottery ticket style stock.
- [23:00]
A
It's ironic actually that at the moment, actually over the last decade it's been the lottery type investments which have really paid off. It's growth stocks.
- [23:09]
B
It's not about value, but that's what I mean. It depends where you draw the line. Google's done incredibly well. Was that a lottery ticket? To me, no, it's on the right side of the line. It's always had a fortress balance sheet with low debt. It was a growth stock, sure, but it's not a lottery ticket in the same way that MicroStrategy is or now strategy that's obviously also done pretty well in fits and starts, but its foundation is less solid.
- [23:36]
A
Or any of those meme stocks that exploded and then collapsed, all of those would be in the same bucket, wouldn't they?
- [23:42]
B
Yeah. So there's degrees of gambling, I would say in the stock market.
- [23:47]
A
Leverage. That's another way of looking at leverage, which is that it is a lottery ticket investment. So you could take something which is really boring, like an index fund, and turn it into something which is exciting and that's easier to market to this group of people and often leads to bad outcomes. So I think that's a danger.
- [24:05]
B
I do find it interesting, though, that the kind of temperament that loses money on average by taking too much risk and gambling does seem to have a recognizable demographic signature, if you like. I mean, presumably the people marketing these products know about these demographic signals.
- [24:26]
A
Is that right, though? I mean, do you think they should be allowed to do that and to encourage this bad behavior and target that demographic? Even though it's really a bad outcome for those people, what they should be doing is trying to educate them rather than steer them in this direction of something which is going to hurt their wealth.
- [24:45]
B
That would seem the ethical thing to do. And there's a weird opposite thing going on as well, where sensible investing content, like I would say we are. We don't give advice, we don't push people into doing crazy things. If we ever put out anything with a clickbaity title targeted at young men, people are going, duh, don't put a clickbaity title on it. If we don't, they're not going to watch it and they're not going to get this wonderful content. I don't know. There's no way to win, really.
- [25:11]
A
But I think that's a really good point, which is that the algorithms themselves amplify the content, which is going to be harmful for people, and it punishes the channels and the platforms which do the right thing.
- [25:23]
B
But to continue on with the gambling theme, let's look at some profiles of people who are actually surprising winners in the stock market. An interesting paper called hedge fund hold' em from 2019 found that fund managers who are good at poker, and this was measured by those who actually cashed poker in big poker tournaments, they outperformed. It seemed like being good at Texas hold' Em poker meant you were going to be a better hedge fund manager and deliver better returns for your clients. And as someone who's played poker myself quite a bit in the past, that wasn't surprising for me because poker is all about a game where you can make great decisions and lose money in the short term. But if you keep making good decisions, you win in the long term. And you have to think really hard about what other people are doing, why they're placing those bets, and you have to be really disciplined. And poker players, to be successful, definitely have to avoid result, orientated thinking where if you lose a hand, you think you did something wrong. That's not necessarily the case. You're operating on imperfect information. And a lot of those things track perfectly onto trading in the stock market.
- [26:36]
A
There was a great book I remember, published a few years ago by Annie Duke, who was a really good poker player. I mean, I've never played it myself herself, and she described really well all of these thought processes that poker players, the good ones, go through. And I just thought, yes, this correlates almost perfectly with what makes a good investor. So it's interesting you mentioned that Bill Gross was famous for this as well. He was a big poker player. The immensely successful bond fund manager who founded Pimco co founded it, I should say.
- [27:06]
B
Let me just read from the abstract of Hedge Fund hold'. Em. So it says the effect is stronger for tournaments with more entrants, larger buy ins, larger cash prizes, and for managers who placed in higher positions or who win in multiple tournaments, suggesting poker skills are correlated with fund management skills. However, after a manager wins a poker tournament, net flows to the manager's fund increase significantly. And along with those higher flows, fund alpha decreases significantly following the tournament win compared to a sample of matched peers, suggesting decreasing returns to scale or distractions correlated with higher net inflows erode the informativeness of the poker win signal. Given this, hedge fund investors would be better off investing in an otherwise similar manager without poker tournament success.
- [27:59]
A
David Einhorn's the famous one, isn't he? He runs Greenlight Capital and he's a very famous poker player, a very good one. But maybe it's too late for him. Maybe he's already been successful. It must be a pretty small sample, I'm guessing.
- [28:13]
B
Yeah, it's a small sample.
- [28:15]
A
Yeah.
- [28:15]
B
But again, as someone who likes poker, I applaud the finding. That's how all academic research should be approached. Does it sound right? Does it make me feel good? Yeah, I believe it. But let's keep going on these professional managers, we want them to be good at poker. That seems to be true. Do we want them to come from rich or poor backgrounds?
- [28:38]
A
Now, my guess, my prior guess, so let's make sure this confirms it, would be that poorer people have more of an edge because once you're wealthy, you kind of lose the hunger, if you know what I mean.
- [28:51]
B
It does seem that fund managers who've come from poorer backgrounds, as in their parents, weren't as rich, do deliver better returns. So there's a paper. Family descent as a signal of managerial quality from 2018 and they use census records about the parents of fund managers. And there did seem to be higher alpha of more than 1% per year for those from poorer rather than rich families. But they believe the mechanism is selection, as in our biased society, which is driven by a who you know, factor, makes it much harder for someone from a poor background to become a fund manager. So that the ones that do must be so good that they're going to outperform, like the random rich kid who's running a fund.
- [29:41]
A
Oh, I believe that. It just reminds me of that movie Trading Places, where you've got Dan Aykroyd, who's the kind of really rich guy who's really entitled, who runs some kind of trading company, and then he loses his job to Eddie Murphy, who's a guy they pick up off the street because he has a kind of intuitive feel of Marcus. Brilliant movie. Have you seen it?
- [30:03]
B
Well, it came out before I was born, but I think I have seen it a long time ago. But, yeah, if I had to pick, I don't know if I want Dan Aykroyd or Eddie Murphy running my fund.
- [30:12]
A
But if you had a choice between Louis Winthorpe III and Billy Ray Valentine, you'd choose the latter.
- [30:20]
B
I guess I would. But what's interesting to me is that a lot of the stuff we've discussed so far conflicts so overtly with that mental picture a lot of people have of a successful stockbroker or whatever. You imagine them driving the flash car, coming from a rich background, being super brash, super confident, shouting across the trading floor, when all of those things seem to mean worse performance.
- [30:47]
A
And in England as well, I think it comes with some kind of class connotation that somebody's going to be plummy, therefore they'll be good at running your fund, whereas someone who's a barrow boy is not going to be a good fund manager. Whereas actually the opposite is true.
- [31:01]
B
On average, I just want to say, on average, every so often in this podcast, so people don't write in and go, yeah, what about this person? There was a whole class of papers I came across which are generally based on very small sample sizes because of how they had to do the research, which is around emotion and biology when it comes to trading. And there are some studies where they've kind of wired up professional traders to show the physiological responses to market events, so things like heart rate and skin conductance. And there was one paper which only looked at a handful of professional traders, but it seemed to show that the more experienced traders reacted less so Their heart rate didn't go up as high when there was some big market event. Which I guess shows that emotional regulation can be learned a bit.
- [31:51]
A
Yeah, the way I've heard it described is that you should be stateless. If you lost a billion yesterday, today you should trade exactly the same way as you have in the past and just treat every day as a new day, a new problem to solve. And I guess part of that is keeping your cool, not being stressed out by what happened in the past, and then panicking, taking too much risk and screwing things up.
- [32:15]
B
And there was another paper, Fear and Greed in Financial Markets. A clinical study of day traders where they looked at, I think it was 80 traders over five weeks, and they showed that the ones with the most intense emotional reactions to gains and losses performed significantly worse. Which I suppose confirms our biases. Again, small sample size, but it's hard to do that kind of study with thousands of people. But all this stuff is around trading, which we generally aren't talking about, are we, with long term investing?
- [32:44]
A
I mean, this is a point which is trading and investing are very different processes.
- [32:48]
B
But there's a few shaky kind of trivial findings across different papers that I think it's worth mentioning in passing. So one paper looked at the kind of car hedge fund managers owned and found satisfyingly that sports car ownership take more risk but deliver lower returns. So almost 3% lower per year alpha, 16% greater volatility and higher fraud rates. Whereas if you wanted to pick a fund manager by what car they own, go for the minivan driver who outperform on average by more than 3% per year.
- [33:26]
A
So just go to the car park outside your fund manager and count Lambos. Is that the way we approach it?
- [33:32]
B
If you're not doing that kind of due diligence, you're leaving money on the table, Romin. That's what I'm saying. It's a fun proxy though, isn't it? Again, I guess it ties back to the approach to risk. Whether you believe that specific finding, the research tends to suggest you want a manager who is careful about risk, not gung ho.
- [33:53]
A
So that was about fund management, but it also applies to buying single stocks, right? If you look at the CEO and whether they've got a pilot license, that also has an effect on their performance.
- [34:05]
B
Do you want your CEO to be flying Cessnas on the weekend?
- [34:09]
A
The answer is no. So if the CEO has a private pilot license, then they run a firm with higher equity volatility, more leverage, and more often value destroying acquisitions. So what career would be good for a CEO? Well, ex military, apparently they tend to pursue conservative policies. They've got less debt, they commit less fraud and they serve longer. 7.2 versus 4.5 years. And if there's a downturn, they fare better.
- [34:40]
B
I think the trouble is that paper's from quite a while ago and there are far fewer CEOs with military backgrounds now. In the 80s there were loads of them.
- [34:48]
A
I know for fund managers as well, there were some companies that would almost exclusively recruit from ex military people.
- [34:55]
B
I suppose people who've served as a general or a commander or something in the military have been so conditioned into rules based discipline. And that system two slow thinking, not making rash decisions, that maybe it's a genuine effect and not just like a statistical accident.
- [35:14]
A
Yeah, business is like war in many ways. Rapid decision making under a very stressful scenario. That's essentially what it is.
- [35:23]
B
And keeping your cool while everything's sort of going off the rails.
- [35:26]
A
Yeah, I could see why it would apply.
- [35:29]
B
Whatever background someone's coming from to run money or run a company, there is a danger of overconfidence where being an expert in one domain gives you an overconfidence in another domain that's unrelated. So there's this classic idea that doctors make poor investors because they're overconfident, they're a brilliant doctor, they're clearly intelligent, have had to do a lot of rigorous work to get where they are, and therefore think that makes them able to pick stocks generally or able to pick pharma companies specifically. And there's no evidence that they can do that.
- [36:04]
A
All I would say is that I do notice when I speak to people and look at their portfolios, they tend to have a bias in their own domain of knowledge. So for IT people, they buy tech stocks, for doctors they buy pharmaceutical stocks, assuming they have some kind of informational edge. Whereas I suspect that actually hurts their performance. Because while they might have an informational edge in their daily career, that doesn't necessarily follow over into investment because it's not just about whether it's a good technology or a good drug. It's about how profitable it is and whether that's been marketed effectively. And that's a whole different domain expertise, I think.
- [36:47]
B
Okay, controversial one. Is getting married a good thing for a hedge fund manager or is getting divorced a good thing for a hedge fund manager? What do you think?
- [36:59]
A
My guess would be that divorce would be damaging because I just remember my mind was shot to pieces during my divorce because it's just so stressful. And upsetting. And it makes you, I'd say it makes you a worse decision maker.
- [37:13]
B
Well, according to the paper, limited marital events and hedge funds, divorce is bad for performance costing around 7.39% in a six month window surrounding the divorce. But marriage is Even worse with 8.5% relative negative performance around the wedding. Very, very small sample size though here. 98 marriages and 76 divorces over 18 years.
- [37:43]
A
Now all of this stuff makes it seem deterministic, doesn't it? Your career, your background, your gender, you know, all of this stuff essentially determines whether you're a good or bad investor, whereas that's not true. And in psychology there are always twin studies where they look at identical twins and they look to see what proportion of a behavior or a phenotype is determined by your genotype, your genes.
- [38:10]
B
Can I suggest the paper the genetics of investment biases from 2014?
- [38:16]
A
A fine paper, Michael. Thank you for suggesting. They found that 45% of the variation in biases came from genetic effects. So that means There's a whacking 55% which is non genetic, which you can affect by changing your behavior, by learning. Now people always talk about whether we should teach finance in school and always say oh yes, well the answer is yes, but in fact the evidence doesn't suggest that that's going to make a massive change. Right.
- [38:50]
B
There was a meta analysis of financial education and it had a very, very small positive effect on financial behavior. But the effect decays very quickly apparently, which makes sense to me. Like I've forgotten a lot of what I learned at school. Not just about finance, but about anything. I can't speak French anymore. So it seems that a better approach to education is little and often rather than just a big dump when you're 18.
- [39:15]
A
And I think you've got to want it, you've got to want that education. When I speak to adults about investing and they've already lost money by overtrading or too much risk, you bet they're interested and you bet that changes their behavior. They're much more receptive to the information once they've been burnt. And I found the stuff about meditating really interesting because it's not something I've ever done. I'm not really a meditating guy. But it's interesting that that does have an effect, a positive effect on outcomes, maybe by being more reflective, by taking time to think about things, not being emotional. I think it's called being intentional.
- [39:54]
B
Yeah, I'm not a great meditator either, but some people swear by it. I think you need to find something that makes you slow down your decision making when it comes to investing and avoid emotional reactions. Whether that's a set of strict rules you stick to, whether that's being disciplined about how frequently you look at your portfolio. So not too often. Whether that's giving you a cooling off period after you make a decision. So you think, I'm going to buy that fund, but I'm going to wait three days just in case I change my mind. All of that stuff might help you.
- [40:26]
A
I've heard a journal helps where you write down what you're going to do before you actually do it. Because then when you read it, it forces you to be more objective in how you look at that decision. It's almost as if you're criticizing someone else's idea if you read your own writing a few days later.
- [40:43]
B
It's kind of related to that delay effect I talked about. Separate the decision from when you actually implement it. And all of this is really driving at the fact that there is again, a robust finding that investors invariably underperform the funds they have invested in. Now there's a dispute over how big that gap is. Morningstar reckons it's more than 1% per year over the last decade.
- [41:06]
A
I know everyone quotes the Dalbar study.
- [41:09]
B
Yep. Again they find an underperformance gap. Though there have been more recent papers that re examine Morningstar's data and argue that the gap is significantly smaller than 1%. But either way, it does seem to exist. And there's that apocryphal claim that the best investors are dead investors. People quote often this Fidelity study, which I can see no evidence for, that the best investors on record are people who have died and therefore don't fiddle with their accounts.
- [41:37]
A
But that would be such a good story if it was true. I always talk about that study, but
- [41:42]
B
this study doesn't seem to exist. If anyone can find it, send it to us. But there have been people on the Bogleheads forum trying to hunt it down. It doesn't seem to be out there, though it does seem to be kind of true in that the people who log into their accounts less frequently are expected to do better than the ones tinkering every day.
- [42:02]
A
If you did want to steer your behavior in the right direction, another approach is to be part of a community with this long term mindset. To learn more, just go to pensioncraft.com membership
- [42:18]
B
okay, today's dumb question of the week. Are cats better stock pickers than fund managers?
- [42:25]
A
Now, Teddy would not like this but the answer is yes. And given our love of tenuous results with small sample sizes, there is a famous case to prove this.
- [42:37]
B
So back in 2012, the observer newspaper ran a year long stock picking contest between three city professionals, a wealth manager, a stockbroker and a fund manager, a team of school children and a ginger cat called Orlando. Who do you think won? Romin, who came out on top? Orlando did it.
- [42:58]
A
Oh, so everybody got five grand to start with pretend five grand, it's a paper portfolio. And then they got five stocks from the FTSE all share which they had to choose and then every quarter they got to reshuffle those stocks. Now obviously the professionals were using their huge skill and training and Orlando in contrast, threw his toy mouse at a grid of numbers. That's how he chose.
- [43:26]
B
So how did it finish up at the end of the year? Well, the professionals had a positive return. They grew that 5,000 to 5,176 pounds. But Orlando shot the lights out. More than a 10% return. 5,542. What a cat. The school kids, however, lost money. 4,840 pounds were left.
- [43:48]
A
Now you might think that was a one off, but in fact there's a long line of these comparisons where you compare something which is essentially random with very careful stock picking. Now, the grand old man of finance research is Rob Arnott. And his team simulated 100 dart throwing monkeys across 50 years of US data. And the monkeys absolutely trounced a cap weighted market benchmark. And they did that 96 times out of 100. What was even more interesting is that they looked at what they called upside down or inverted strategies. So they took the weighting algorithms of well established strategies which supposedly would be good, and then simply flipped the weighting. So it should do the opposite and be awful. But it turned out that the inverted versions generally delivered not only higher returns, but also better sharpe ratios, better information ratios, better CAPM alphas, outperformance.
- [44:49]
B
In other words, it's all interesting stuff, isn't it, as people who generally invest in market cap weighted index funds that random portfolios, whether picked by monkeys or any other animal, might outperform. And is that to say often in history the equal weighted benchmark has done better than the cap weighted index?
- [45:10]
A
Yeah. The explanation from Arnott and his co authors was that inadvertently this tilted towards
- [45:16]
B
value strategies which over the long term have done really well.
- [45:21]
A
Yeah. So if you tilt to small caps to value long term, it's outperformed whether that's a monkey throwing darts or whether it's a fund that deliberately does that. It has outperformed.
- [45:33]
B
But Rob Arnott wrote this paper back in 2013. I'm hoping the monkeys have been obliterated over the last 13 years since then as growth has trounced value. But doesn't a lot of this come back to that classic book A Random Walk Down Wall street from the 70s, where Burton Malkiel says that blindfolded monkeys throwing darts at newspapers to pick stocks would outperform the professionals? Which did seem to be true.
- [46:00]
A
You know, Michael, we've come up with a lot of ideas for funds over the years, but I think this could be the one.
- [46:07]
B
Monkeys, cats, dogs. I've always said it like we've got junior ICers and adult icers, Pet icers. Let Teddy have his own money and he doesn't need to pay tax on it. Thank you for joining us for Many Happy Returns. Keep sending us your questions no matter how dumb at Emmett.
- [46:26]
A
And do remember to check out pensioncraft.com for all the information about our membership courses and investment coaching options.
- [46:34]
B
Many Happy Returns is a Pensioncraft production co hosted and executive produced by Romin Nikiza and Michael Pugh. This podcast is for informational and entertainment purposes and is not financial advice. We do not provide recommendations or endorse any decision to buy, sell or hold any security. We cannot be held responsible for any actions listeners may take and investors are encouraged to seek independent financial advice.