Past Performance – An Investing Contradiction
We’ve been told over and over by the traditional financial services industry to look for the best investment. In our search for the best we often use past performance. Doing so makes sense since we rely on past performance for other decisions.
For instance, if a university needs a new basketball coach they start by reviewing a coach’s track record. Does he win more than he loses? However, in a crazy paradox, selecting an investment manager using past performance may not be the best choice. But how is this possible? Hiring someone who performed terribly makes little sense.
The Disciplined Manager Search Process
Years ago I defined a disciplined process for selecting mutual funds. I analyzed the fund and made sure it matched the investment manager’s description. And, of course, we reviewed past performance to make sure the manager had done well. This process led me to suggest Davis New York Venture Fund run by Christopher Davis. Once I hired Davis, I had a strict monitoring policy to ensure “due diligence.” If a manager slipped I wanted to fire them before it became a problem. Of course you know what happened next…after a few years, Davis experienced a normal period of underperformance, but based on my disciplined set of rules, I put the fund on the sell list.
A few years later, the same process put Davis back on the buy list. I remember one client call where I suggested he buy Davis again. This client expressed the confusion I suspect other clients felt. “But Carl, didn’t we just sell Davis two years ago?” He was right. I did tell me clients to sell their Davis fund holdings just a few years earlier because the “disciplined manager search process” said we should. Now it said to buy Davis again.
Planting a Tree, Not Hiring a Coach
Even using a disciplined process and the best data we can find, “smart” activity often creates a behavior gap. The reality is that even if you own a mediocre investment, but if you behave correctly (sometimes that means doing nothing), you’ll outperform 99% of your neighbors.
In the end, successful investing is more like planting an oak tree than hiring a basketball coach. You never plant a tree and then pull it out every time the wind blows just to check the roots. This simple, but not easy, approach reminds me of Warren Buffett who said that, “Benign neglect, bordering on sloth, remains the hallmark of our investment process.”
Based on many conversations I’ve had, this attitude feels wrong. It seems un-American, a contradiction to the Protestant work ethic. If something isn’t painful or hard it’s not worth doing. But when it comes to investing, we’re dealing with a different animal. Once we’ve made a decision based on our personal goals and plans, often the best thing we can do is practice benign neglect. Simply do nothing, even though it feels wrong. Try it. I think you’ll find that trees grow much better when you stop looking at the roots all the time.
This sketch and post originally appeared in the Behavior Gap Newsletter March 24, 2011. Sign up for the Behavior Gap Newsletter.
