Out of time

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“Investment based on genuine
long-term expectation is so difficult today as to be scarcely practicable. He
who attempts it must surely lead much more laborious days and run greater risks
than he who tries to guess better than the crowd how the crowd will behave;
and, given equal intelligence, he may make more disastrous mistakes.. It needs
more intelligence to defeat the forces of time and our ignorance of the future
than to beat the gun. Moreover, life is not long enough; – human nature desires
quick results, there is a peculiar zest in making money quickly, and remoter
gains are discounted by the average man at a very high rate. The game of
professional investment is intolerably boring and over-exacting to anyone who
is entirely exempt from the gambling instinct; whilst he who has it must pay to
this propensity the appropriate toll. Furthermore, an investor who proposes to
ignore near-term market fluctuations needs greater resources for safety and
must not operate on so large a scale, if at all, with borrowed money – a
further reason for the higher return from the pastime to a given stock of
intelligence and resources. Finally it is the long-term investor, he who most
promotes the public interest, who will in practice come in for most criticism,
wherever investment funds are managed by committees or boards or banks. For it
is in the essence of his behaviour that he should be eccentric, unconventional
and rash in the eyes of average opinion. If he is successful, that will only
confirm the general belief in his rashness; and if in the short run he is
unsuccessful, which is very likely, he will not receive much mercy. Worldly
wisdom teaches that it is better for reputation to fail conventionally than to
succeed unconventionally.”


Maynard Keynes, ‘General Theory of Employment, Interest and Money’, 1936.


In the ‘bible’ of behavioural
investing (‘Behavioural Investing: a practitioner’s guide to applying
behavioural finance’), James Montier amongst many other things addresses “just
how ridiculous the obsession with the short term actually is”. He imagines a
universe of 100 fund managers, each with a 3% alpha¹ and 6% tracking error². An
alternative way to describe this cohort is as a population of 0.5 information
ratio³ investors. “An information ratio of 0.5 is pretty good. According to
Grinold and Kahn (2000) an information ratio of 0.5 would put these investors
in or close to the top quartile.” See Table 1 below.

So Montier creates a little universe of quite good investors and then
hits them with random shocks. Each of these fund managers, we should remember,
has a “true alpha” at inception of 3%. Montier allows these managers to run
money for 50 theoretical years and tracks their performance over time. The results
are instructive..

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