Don’t Just Do Something—Stand There

By Simon Hallett, Vice Chairman | May 26, 2021

Humans prefer to do something rather than nothing. We like office environments that are a “hive of activity” and commend “men of action.” When stuck in a traffic jam, we will take an alternate route just to keep moving, even if it prolongs the journey. We tend, though, to conflate activity with productivity, mistaking the people whom we see doing the most with those who are the most valuable.

We see this bias in many domains. Our political leaders tend to respond to a crisis with ill-considered policies that capture attention but often do little good and may even do harm. It would be unacceptable for them to stand by and simply do nothing. While serving as both vice chairman of Harding Loevner and as chairman of a professional soccer club that competes in the English Football League (EFL), I have been struck by the parallels between investing and sports when it comes to the biases that damage effective decision-making. Studies have looked at penalty kicks in soccer. When a penalty is awarded, the ball is placed 12 yards from the center of the goal and a kicker gets the opportunity to score with only the goalkeeper standing in the way. It turns out that because of the goalkeeper’s bias for action, the optimal place to kick the ball is directly at the center of the goal. A goalkeeper will almost always dive one way or another in anticipation. If he dives the wrong way, he’s forgiven as having simply guessed wrong, or as being sent the wrong way by the kicker’s supposed feint. If he dives the right way, he has a chance to stop the ball entering the goal. If he merely stands in the middle, however, he is the subject of much abuse for doing nothing.

Investors fall victim to similar pressures and impulses. The immediate costs of transacting are low, and the propensity to transact is high. The result is that investors transact too much, and their returns suffer. They tend to transact at the wrong time, buying after prices have risen, and selling after prices have fallen.

Underlying these behaviors is a general misunderstanding of the roles of luck and skill. In sports and in investing, short-term results are the outcome of a combination of the two. Yet, we tend both to attribute the outcome more to skill than to luck and to extrapolate a series of outcomes (good or bad) into the future. This tendency stems from our deep-seated need for explanation, and a need to feel we are in control even when we are not. This occurs particularly in those sports, like soccer, that are generally low-scoring affairs. Unlike in basketball, for example, where there will be more than a hundred points in a game, the average number of goals in a professional soccer game is roughly three. The result of a single game will largely be driven by luck—one bobble of the ball, the inches between hitting a goalpost and scoring, a poor refereeing decision. Yet the narrative in post-match interviews is seldom “we got lucky.” At least, it’s seldom the case that “we got lucky” when the interviewee’s team wins. When the team loses, the loss is the result of bad luck! How similar this is to investment narratives, where there seems to be only two kinds of investment managers: the talented, and the unlucky.

Benevento,Italy,,February,4,,2018:,Lorenzo,Insigne,Of,Napoli,Hits

At my own club, last season, we had a pair of games scheduled close together. In the first, we gave up a 1-0 lead late on and ended up with a tied game. In the second, we scored a late goal from an unexpected source to win 1-0. The narrative of the first was that “we didn’t know how to hold a lead,” and of the second that “we were gutsy and played to the end.” Same team, same players, both close games, but different outcomes drove radical differences in explanation.

As in investing, in sports a series of poor results needs a narrative to explain it, and action to reverse it. Often that action is to replace the coach. Acting to replace him when results go the wrong way attributes far too much causality to the coach. George Steinbrenner famously hired Billy Martin five times as coach of the New York Yankees. Between the Premier League and the three levels of the EFL, more than half of the 92 clubs replaced their manager this season alone. Replacing a manager tends to come at considerable cost—he (it’s always he) will have his own preferences for players and staff, and perhaps may even want to change the style of play completely—with little evidence that the players who actually kick the ball around improve their own performances as a result. Because luck occurs randomly while skill is reasonably constant, after teams are unlucky for a stretch their luck will tend to mean revert. The “manager bounce” is a well-established phenomenon whereby short-term results usually improve after a manager is replaced. It is a statistical phenomenon, though, that has little to do with on-the-pitch performance.

For asset owners, there is a similar temptation to replace a manager after a period when returns have disappointed, but, alas, unlike the fans of a soccer club, the clients of an investment manager do not enjoy the mean-reverting returns that the manager provides those who stuck with them.

For asset owners, there is a similar temptation to replace an investment manager after a period when returns have disappointed. But, alas, unlike the loyal fans of a soccer club, the former clients of an investment manager do not enjoy the mean-reverting returns that the manager provides those who stuck with them. There is plenty of evidence that investors’ urge to act is damaging to their long-term returns. In mutual funds, on average, dollar-weighted returns that shareholders receive from their funds lag the time-weighted returns that the funds generate. This “behavior gap” is directly the result of poorly timed action on the part of shareholders.

Incentives and market structures only make the bias toward action greater. One reason that English soccer coaches get changed is that, once the season starts, players may not be traded outside the month of January. A result is that during the January transfer window it’s almost non-stop activity. The period has become its own media event, with fans, players’ agents, and media pundits all calling for teams to make their moves. This, even though only a few such moves ever have significant impact on a team’s results, and despite evidence that prices paid for players tend to be higher than between seasons.

The investing industry has many incentives to transact; indeed, the revenue models of many participants depend on transactions taking place. When I started in investment management, in London in the late 1970s, our fees were not based on assets managed as is the case today. We were paid when we made a transaction in our clients’ discretionary portfolios. Why is the portfolio turnover of the average equity mutual fund so high, when doing nothing and allowing returns to compound over prolonged periods of time is often a superior way to generate market-beating returns? It’s because the investment industry exploits clients’ bias in favor of action. Managers’ actions are described in emotional terms. We read of “conviction,” of “exciting opportunities” and “story stocks.” The reality is more mundane. Successful investing is about resisting the urge and the calls to action, knowing when to sit on your hands and do absolutely zilch.

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Down the Rabbit Hole

By Peter Baughan, CFA, Analyst and Portfolio Manager | December 15, 2020

In trying to make sense of the state of things today, I found myself thinking of snippets I’ve heard from Lewis Carroll’s Alice in Wonderland. Until recently, however, I had never actually read the story. So, I went to Amazon.com and ordered a copy of the entire Alice in Wonderland Collection (Alice’s Adventures Underground, Alice’s Adventures in Wonderland, Alice Through the Looking Glass, and The Hunting of the Snark). While I was underwhelmed by the character development in these stories, I did find some takeaways that seem relevant today. Still, perhaps the most provocative line from Alice that I came across is one that was written not by Lewis Carroll but by Czech film director Jan Švankmajer for his 1988 film Alice.

The film opens with Alice saying, in part, “But, I nearly forgot, you must close your eyes otherwise you won’t see anything.” After all, Alice would never have experienced Wonderland or journeyed through the looking glass if she had not closed her eyes. And we’d have no Mad Hatter, no March Hare, and, of course, no Red Queen.

I ask myself: If I close my eyes, what do I see…in the markets? What I see is determined by my sense of what ought to be. I think of my introductory college philosophy course and Plato’s famous Forms. For Plato, everything has an absolute form, a universal ”right answer.” What we see on Earth are imperfect replicas of each thing’s true essence or Form. What would the Platonic Ideal look like for valuing a high-growth stock such as Shopify or, closer to our own portfolios, Amazon? When I close my eyes, I see a traditional multi-stage discounted cash flow model with a rapid growth period, a fade rate, and a rationally derived terminal value all discounted to the present using what I’ll call a traditionally derived cost of equity.

Other investors in the market today may see something quite different when they close their eyes. If, say, a Robinhood day trader closes his eyes, what does he see? Or if any of the numerous momentum fund managers close their eyes, what do they see? They may see relative price-to-sales driven by the second derivative of the revenue growth rate or some other relative forward 12-month or forward 3-month ratio as the key variable determining valuation. Or, perhaps today, all that many see are charts and price momentum amid the haze of Fedspeak that seems to devalue much of traditional investment thought. Perhaps investors today don’t see anything to do with ”terminal value” at all.

What do value investors see when they close their eyes? A number of us at Harding Loevner were struck by a recent Wall Street Journal article about famed value investor Ted Aronson’s decision to dissolve his longstanding $10 billion investment fund and return the cash to investors. Aronson, a previously very successful value-based quant manager, said: “It can all work for years, for decades, until or except when the not-so-invisible hand comes down and slaps you and says, ‘That’s what worked in the past, but it’s not going to work now, nope, not anymore.’”

I wonder what ways of seeing are being hard-wired into investors today. Who really speaks today of any of the valuation insights found in Benjamin Graham’s The Intelligent Investor, which was once seen as hallowed ground? I think it’s fair to say that very few market participants see the valuation structure advocated in Graham’s work when they close their eyes today. High price-to-sales seems to have replaced high price-to-earnings as the new normal. So-called modern monetary theory also looms—a new or non-standard to replace whatever fading monetary policy/interest rate standards once existed.

For Aronson, what’s up is down and what’s down is up. What he sees when he closes his eyes, what ought to be, well, it just ain’t so in the markets, and hasn’t been so for years. Aronson is a smart guy. As some of my colleagues noted in a recent client letter, there is no guarantee that what’s become true for him can’t become true one day for Harding Loevner. We don’t think we are any smarter than Aronson, or many other such value managers. We are considerably more fortunate at the moment as the global policy direction in recent years has smiled upon ”growth” while frowning upon ”value.” But further change may be coming.

All of this brings to mind a poem by Rainer Maria Rilke published in 1905:

I live my life in widening circles
that reach out across the world.
I may not ever complete the last one,
but I give myself to it.

I circle around God, that primordial tower.
I have been circling for thousands of years,
and I still don’t know: am I a falcon,
a storm, or a great song?

“I live my life in widening circles that reach out across the world”—not a bad description of investing amid ever more accommodative global monetary policy with its ripples spreading around the world. Or of investing amid a pandemic with the COVID-19 virus reaching out across the world in widening circles. I have the same ultimate question in 2020 that Rilke had in 1905. How’s all this end?

The current environment sometimes makes me think about the scene in the film Doctor Zhivago (sorry about the mixed references, but my eyes are still closed) when the good doctor returns to his family home one day to find it taken over by the workers’ committee. He is initially assigned to only one room and eventually is not allowed to enter at all. Standards changed, to say the least. More than at any time I can remember, I’d say the standards that underpin what passes for majority understanding and opinion, in the US anyway, are in flux. For example, would a proposition to reaffirm the US Constitution as written, if put to a popular vote today, win majority approval? I have my doubts. Would a proposition to reaffirm support for “free market capitalism,” if put to a popular vote today, win majority approval? I have my doubts. Would a proposition to reaffirm the principle of private ownership of land, if put to a popular vote today, win majority approval? I suspect this would still find majority support, but with a large vote against, and I’m not sure how the vote would turn out, say, five years from now. Yet the stock market has no such doubt. The best stocks in the market, by many country miles, are high-growth stocks where share prices reflect confidence in rapid earnings growth a decade or more from now—at least according to the arithmetic of discounted cash flows. Or perhaps that’s not how many investors look at it; they may only have confidence in sustained earnings momentum one to two quarters from now, not confidence in the state of things in, say, December 2030.

I did not find reading Alice’s Adventures in Wonderland and Through the Looking Glass to be a particularly satisfying experience. However, they were useful to read. As I reflect on it, the stories made me step back from my assumptions about how things should be, and left me open to considering other scenarios, in politics, in society, and in the financial markets. The meaning of the line “you must close your eyes or you won’t see anything” is not entirely clear to me. But it is perhaps the most provocative and potentially valuable investment insight I’ve come across in quite a while. While I ponder and watch, I plan to remain diversified and see just how prescient Alice’s upside-down world continues to be.

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Too Much Information

By Simon Hallett, Vice Chairman | March 03, 2021

In the late 1950s, in his book Common Stocks and Uncommon Profits, Phil Fisher recommended making investment decisions based on “scuttlebutt,” the kind of information an investor could get by asking around. This entailed tracking down and interrogating customers and competitors, employees, and former employees. Doing research, in the sense of gathering evidence and analyzing it to reach a conclusion, was hard work, but enabled analysts committed to such intellectual labor to obtain an edge over their competitors simply by having better, and more complete, information.

Indeed, when I started my career in investing in the late 1970s, obtaining even basic financial info about a German car company still required going to Germany and knocking on the company’s door.

Now gathering information no longer takes much effort. We are deluged by floods of data—not only the details of prices, volumes, margins, and capital investments of individual companies, but also highly granular data about credit card receipts, numbers of cars in parking lots, or words used in media reports. These new, “alternative” sources of information have briefly given some stock pickers a slight edge in predicting short-term stock price movements. The informational advantage provided by such data is but fleeting, however; once this data is commercially accessible to everyone, the advantage disappears. Thus, even for the short-term investor, information gathering itself no longer provides a lasting edge.

For long-term investors, the relationship to information has changed even more fundamentally. You no longer need to seek information; it finds you. Your job, rather, is to act as what Lou Gerstner, the former CEO of IBM, called an “intelligent filter”—determining the information that is important and ignoring data that (in the case of the investor) doesn’t help you forecast cash flows and estimate the value of a security.

The fact that filtering information is the long-term investor’s task, of course, doesn’t prevent most from feverishly pursuing every bit of information they can about the companies they follow. Egged on by the 24/7 news cycle, internet chat rooms, and by data providers to know their companies in as much depth as possible, investors often seek to become experts in every aspect of each company’s business. It’s dubious whether this helps them make better estimates of what a company’s shares are worth. Instead, the evidence suggests that, beyond a certain amount, each extra piece of information has zero marginal impact on forecast accuracy. The impact remains positive, however, on the investor’s confidence in their forecast.

The evidence suggests that, beyond a certain amount, each extra piece of information has zero marginal impact on forecast accuracy. The impact remains positive, however, on the investor’s confidence in their forecast.

In one unpublished study, described in Winning Decisions by J. Edward Russo and Paul J. H. Schoemaker, people who handicap horse races were asked to predict, based on increasing amounts of information, which horse would win a race. They found that, beyond a very limited amount of data, forecast accuracy did not improve with more data, but the handicappers’ confidence in their forecasts continued to grow with each extra bit of information.

Knowing more makes you feel better, in other words, but doesn’t help your decision-making. In investing, feelings and actual results arguably are even more disconnected. After all, feeling good about a decision is rarely a help in successful investing—to have a good outcome, an investment view must be different from that of most other investors, and standing apart from the herd almost always leads to discomfort.

Sitting on Our Asses

The job of an investment analyst, then, when forecasting a company’s business prospects and the price that should be paid for its stock is to distinguish between what is important—the signal—and what is useless noise. That’s what we do at Harding Loevner. Our “common language” is designed to guide investment collaboration by helping us focus on low-frequency signals that are important to a long-term investment thesis and avoid being distracted by torrents of high-frequency information that obscure the relevant underlying issues.

We recognize that our industry has an extensive tradition of emphasizing high-frequency signals to induce transacting. In the past, much of the revenue associated with financial services was transaction-based. Brokers were paid only when customers transacted (indeed, when I started my career, so were investment managers!). Unsurprisingly, brokers devoted great effort to stimulating customers to act. Customers responded as you’d expect them to—humans like action, not sitting still. Although the investment management industry has shifted in recent years to replace commissions with asset-based fees, there remains a popular expectation that a good investor will be active, including taking advantage of the most readily available and highest-frequency bits of information: stock price movements (both up and down).

Few investors, though, are able to capture any benefit from high-frequency signals. Our analysts don’t even look at stock prices until a company has been thoroughly researched and qualified as meeting our quality and growth criteria, its long-term cash flows have been forecast, and the fair value of its shares estimated.

Stock prices are much more volatile than the underlying qualities of the business they are supposed to reflect. Investors should remember the words of Charlie Munger, who said successful investing is a matter of “finding a few great companies, then you can sit on your ass.”¹ Of course, while we spend a lot of time following Mr. Munger’s advice, that doesn’t mean we are sitting still. We are constantly questioning our assumptions, testing our hypotheses, updating our information and, occasionally, as a result, changing our minds. Usually, though, ignoring the calls of those whose business model, if not entire worldview, revolves around urging you to move is the key to success.

Compounding the Effect

An investment process structured around the long term, and asking questions about long-term strategy not short-term results, will focus on a few fundamental signals that show a company’s progress in creating value for its shareholders. It will focus on competitive structure of an industry, and durable competitive advantages, rather than on the outcomes of the recent past. It will take what you’ve learned and use that to forecast a company’s investments in its business and the cash flows those investments should generate over long periods of time. Only then can you make an informed guess as to what a company is worth and compare it to what the market is inviting you to pay.

A process focused on the long term also recognizes the importance of compounding—that over a long holding period, even if you did overpay, the rate at which a company continually reinvests its cash flows will be a much more important contributor to your return. In an era when information is so democratized, our one true edge is an ability to latch onto a few incremental competitive advantages that we’ve identified in a company, and allow the company to do its job over the long term and provide the power of compounding to our clients’ portfolios.

In an era when information is so democratized, our one true edge is an ability to latch onto a few incremental competitive advantages that we’ve identified in a company, and allow the company to do its job over the long term and provide the power of compounding to our clients’ portfolios.

Humans invariably underestimate this phenomenon. Compound interest is one of the wonders of the world, yet few people understand how powerful it is. It appears our brains are designed to deal with linear, not exponential progressions.

If there was any doubt about our difficulty in intuiting the power of exponential growth rates, look at how unperturbed most people were a year or so ago when COVID-19 began spreading, first in tiny increments. People could not grasp what the impact of a very standard exponential growth curve could be until it was sloping nearly vertically upwards.

A long investment time-horizon also benefits from the long term being more predictable, despite being the sum of a series of short-terms. When some luck is involved, individual outcomes are unpredictable, but the rules of probability dominate as the number of independent trials and outcomes increase. The outcome of a single spin of a roulette wheel, a roll of dice, or draw of a card is unpredictable, but in the long run the house’s victory is as near a certainty as we can get in this world.

Our job is to turn the coins we toss into unevenly weighted ones, by being disciplined about the information we use, diligent in our research, and allowing the companies in which we invest our clients’ capital to do the heavy lifting for us.

Endnotes

¹Charlie Munger, Berkshire Hathaway Annual Meeting, 2000.

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Stock Portfolios, Football Teams, and the Stories We Tell Ourselves about Each

By Simon Hallett, Vice Chairman | July 09, 2021

The world is complex and unpredictable, but humans prefer order, and cause and effect, so therefore tell stories that purport to explain what is simply random. Narratives pre-date writing. They help make events coherent and memorable, while arousing emotions in the listener. Behavioral biases, which all humans share, are in many cases essentially products of the stories we tell ourselves. The more detailed the story, the more entertaining it is and the more powerfully it can affect our emotions. We love stories. That can often be wonderful, but in decision making it can be dangerous.

In investing, there has been at least a little progress towards improving decision making by resisting the power of stories. Quantitative investors describe how they adhere to purely objective rules (rules and lines of code that, of course, they themselves have written) to govern their behavior and reduce bias. “Quantamentalists,” another breed of investor, allow some judgement to enter their decision making once they have established the framework. They do this in part in recognition that, as a rule, most humans don’t like rules. We suffer from what psychologists call “algorithm aversion,” i.e. preferring to go with our gut. That preference results from our need to remain in control, or at least to believe we are. Permitting human override of an algorithm may degrade the quality of its output, but in granting themselves the comfort of exercising some degree of control, decision makers likely improve their rate of adherence, for an overall improvement in outcomes. I fully expect self-driving cars to come with a steering wheel that will have no impact on direction of travel, but will allow the human passenger to feel more secure than if she were simply sitting back and giving herself over fully to the computer under the hood.

In his book The Success Equation, Michael Mauboussin writes extensively about the importance of a strong process and rules in activities where the immediate outcome is driven by luck and skill. He describes how it is possible to improve skill through what has become known as deliberate practice: repetitive, purposeful, and systematic repetition with immediate and specific feedback. Luck, however, can only be managed by having a strong process, with rules or standards constraining decision making and the urge to impute too much importance to our role in any one result. In activities such as investing or team sports—arenas where skill and luck both come into play—narrative is particularly seductive, making adherence to this recipe for success a constant battle.

The pandemic meant the stands were still empty at “Theater of Greens,” the home stadium for Plymouth Argyle this year, but the ideas were plentiful as to how to harness the theories of behavioral economics to put a more competitive squad on the field.

Richard Thaler, who won the Nobel Prize in Economics for his work in behavioral finance, has noted that 1980s basketball superstars like Larry Bird converted their three-point shot attempts at the same near-40% rate as 21st-century sharpshooters such as Steph Curry or James Harden. Yet, Bird took half as many three-point attempts as are normal today, favoring shots closer to the basket, which great players can hit roughly 50% of the time. It took 30 years for the three-point shot to become as popular as it is today or, in other words, for basketball to realize that 0.4 x 3 is greater than 0.5 x 2.

The Bill James Baseball Abstract, an annual compendium of baseball statistics that ultimately legitimized the science of baseball sabermetrics, was neglected for many years before a James disciple, Oakland Athletics General Manager Billy Beane, used the approach to identify underpriced skills for his small-market team, as popularized in Michael Lewis’s 2002 Moneyball. It was only then that James himself landed a job in the front office of the Boston Red Sox, helping the team finally overcome the “Curse of the Bambino,”¹ and win its first World Series in 86 years.

Many baseball fans complain that the influence of Moneyball has been too great—players are chosen purely for their ability to walk or jack balls over the fence; defenders are all stacked on one side of the infield because that’s where the statistics say the vast majority of a given batter’s ground balls will be hit. “It’s no fun anymore!” Clearly, those fans prefer intuition and stories to success and efficiency. They also subscribe to the great man theory, that results are driven by individual managerial genius, the wizened skipper playing a hunch.² And yet, organizations typically strive to create and adhere to processes that can improve their probability of success—to control luck.

I have been involved in two firms with many similarities, one being an investment manager and the other a football (soccer) club. An investment portfolio can, through careful construction, be more than the sum of its individual parts thanks to diversification. It may seem odd, but a football team is a portfolio. It, too, needs careful construction. You can’t simply rank order the most attractively priced available players and take the top 20 to form your squad. You would end up with a team made up only of defenders, and no goal scorers.

More than a decade after John Henry, the Red Sox owner who had hired Bill James, purchased Liverpool FC and brought Moneyball to the UK’s Premier League, systematic use of data analytics has finally worked its way throughout the ranks of English football. At my football club, Plymouth Argyle, which plays in the third tier of the leagues, we have set rules and standards to guide the decision-making of those who select the squad. Beginning with our philosophy, i.e., answering the question “What is the style of football we wish to play?,” we have defined the desired characteristics of each position. Our philosophy includes playing the ball forward from the back with quick passes along the ground to the opposition’s part of the field. Our goalkeeper must, therefore, be able to kick with both feet and play short passes while under pressure from the opposing forwards. We also prefer to play in a tactical lineup, known as a 3-5-2, with a pair of strikers at the front and a couple of fit defenders, one on each side, who dash up and down the wings depending on whether we or the opposition have the ball.

Defining the philosophy this way and defining how we will implement it enables us to search databases for players that match our criteria in each position, such as the defender we recently signed based on some impressive data around his defensive blocks, aerial duels won, and tackles per game. Then, in quantamental fashion, we can conduct research into aspects of players that can’t be quantified (yet!), such as their character, personality, or work ethic.

There are differences between assembling an optimal squad of football players and an investment portfolio. One is that securities prices are freely available, updated continuously, and can be compared with their hypothetical value generated by a model. That is not the case with football players. Transactions can only be made in two “transfer windows,” one midway through the season in January, the other during the summer before the next season starts. And no one has yet come up with a model that can assess players’ value in the way that we forecast cash flows and discount them to a present value to give an idea of what a share of stock is worth. I live in hope, though!

The market for football players is relatively efficient, but not completely so, and becomes less efficient the lower down the leagues you go. In this way, the relative inefficiencies of the market are parallel to those for, say, US large caps compared with those for emerging market small caps.

But surprisingly, perhaps, there are more similarities than differences. The market for football players is relatively efficient, but not completely so, and becomes less efficient the lower down the leagues you go. In the Premier League, the most watched football league in the world, there is a strong correlation between what you pay and the results you achieve. That is not the case lower down, so my club has a strong incentive to improve decision making, to exploit the behavioral biases and subsequent mispricing that is prevalent. In this way, the relative inefficiencies of the market are parallel to those for, say, US large caps compared with those for emerging market small caps. Similarly, though, as the potential gains to improved decision making increase, so does the resistance to replacing intuition with algorithms and process that reduces the degrees of freedom under which individuals operate. Those clubs which can overcome that resistance will generate a competitive advantage—an edge. I believe my football club has such an advantage, but I am on the alert for signs of backsliding—going along with “But that’s the way we’ve always done it!”

We have gone down this path at Plymouth Argyle because we want to spend the Club’s money wisely and compete by being smarter, not by spending more. At Harding Loevner we started down this path 25 years ago as decision making spread beyond the handful of founders to an expanded investment team. Each portfolio remained the product of two single decision makers but was now made with input from over 30 analysts. We had to learn how to structure a process that benefits from group wisdom but is not damaged by “groupthink.” The foundation of that was, and still is today, individual accountability and aggregation of individual decisions. Analysts drive the process and decide what stocks they will cover. They are free from direction by their colleagues, and free from direction by portfolio managers. They are not completely free, though. Just as Argyle’s team must recruit players who meet the objective standards we have established as being consistent with our playing philosophy, Harding Loevner analysts must confine their activities to securities of companies that they judge to conform with our investment philosophy, which focuses on growth, quality—which we have historically equated, in part, with a demonstrated track record of profitability—and price. When we look back at the last 25 years, we can see clearly that the arc of evolution of our investment process has been to define more clearly and rigorously the rules that restrict our analysts’ liberty to follow any company they chose. This has been highly effective at controlling biases and risk, and, overall has been good for returns.

Today, there are any number of voices, both internal and external, calling us away from the framework and structure that have served us well. The rise of the digital economy, and its steady proliferation of fast-growing but still-unprofitable businesses with compelling narratives, continually tests our reliance on an established track record as a guide to the future and the best indicator that a company has the culture and institutional strength to withstand cyclical downturns and shifting competitive landscape. Has the nature of growth changed? Have the kinds of characteristics that define quality shifted? Or are those merely the stories we tell ourselves to justify paying higher prices for the hot new fashion?

I don’t know the answers to those questions yet. I do know that, while it is necessary for portfolio managers to evolve along with markets, such evolution should take place deliberately and only after careful consideration. At Argyle we are at the early stages of translating our playing philosophy into a structured process for how we find players, and how they play on the field. Already, though, there have been occasions when we’ve had to adapt on the fly and adjust our typical tactical lineup. Football, like investing, is a game where the opposition can see what we do, and we must adapt to how they counter our plans. Players get injured, and replacement players may be less capable at implementing the approach. So, how we implement our philosophy must evolve, but we must be clear with ourselves that such adjustments are a change in process, not a change in philosophy. If we were to start changing our philosophy, we would surely be lost, tossed on a swirling sea of narrative.

Endnotes

¹Purportedly begun in 1920 when, after he had led the club to three World Series titles in six years, the Sox traded George Herman “Babe” Ruth to the rival Yankees for $125,000 (about $1.7 million in today’s dollars, or roughly the salary of Boston’s current backup catcher, Kevin Plawecki).

²It could be said the great man theory is also a feature of investment marketing—how often do brand name investment managers attract large amounts of client assets and then collapse in ignominy?

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Out of Our Minds

Don’t Just Do Something—Stand There

Down the Rabbit Hole

Too Much Information

Sitting on Our Asses

Compounding the Effect

Endnotes

Stock Portfolios, Football Teams, and the Stories We Tell Ourselves about Each

The pandemic meant the stands were still empty at “Theater of Greens,” the home stadium for Plymouth Argyle this year, but the ideas were plentiful as to how to harness the theories of behavioral economics to put a more competitive squad on the field.

Endnotes

Disclosures