One Question Investors Should Ask Now and Then
The answer might reveal flaws in your thought processes.
Bloomberg, February 16, 2018
How committed are you to a belief system?
Answering that question has the potential to reveal flaws in our thought processes about many things, from politics to economics to cultural issues. Whether you are committed to one big idea, or are fascinated by a variety of things might also determine how successful you are as an investor.
“The better forecasters were like Isaiah Berlin’s foxes: self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability.”
I am so deeply enamored of the phrase “willing to update their beliefs when faced with contrary evidence,” that I decided to do just that: publicly update some of my beliefs based on new evidence. Here are some of my reconsiderations:
High-frequency trading: I have been a pretty robust critic of HFT, based on the premise that trading is a zero-sum game. Whatever profits the HFT traders extract are coming out of slower-speed trading accounts. Sniffing out trades before they are executed and jumping ahead of them sure looks like front-running, which in the traditional sense is illegal. I don’t know if this variant is illegal, but it sure seems wrong.
My views on this have been moderated by (of all things) Vanguard Group Chairman Bill McNabb (interviews here and here). McNabb has made a fairly credible case that HFTs make it easier and cheaper for giant shops like his, which has about $5 trillion under management, to execute orders. It required a rethink of how the firm approached trading, but in the end it seems to be money-saver for a company that tries to pass on low costs to clients who are doing things like saving for retirement.
Facebook influencing election outcomes: No one doubts that the social network’s news feed was full of fake news in the last presidential election. We also understand it spread like the flu, infecting everyone from your trusting grandmother to people who probably should know better.
My initial reaction was that Facebook didn’t tilt the election, and that people’s confirmation bias would get in the way of anyone genuinely changing their vote based on fake news. I still believe that is true, but I am more willing to accept the possibility that in some circumstances, planted Russian agitprop, false flags and counterintelligence can have had a serious effect. I am now withholding final judgment on the election until all of the data is in (UPDATE: This was published prior to this afternoon’s indictment of 13 Russians accused of election meddling).
Hedge funds: My thinking about hedge funds has evolved over the years. The glamour of the hedge-fund rock star is impressive, but I was skeptical about costs and performance.
I still believe these funds are too expensive — but I am willing to make small exceptions for the rare alpha generators who consistently beat their benchmarks after accounting for fees. Good for these money managers and their investors.
My generous guess is this elite group numbers less than 10 percent of the 11,000 or so hedge funds that exist. That reality creates a different issue: Since most are not above average, and so many are below, the vast majority of institutional money cannot find a home with the small handful of outperformers. So my take now is that if you are in a top-performing fund, stay there until the successful investment process is either no longer used or stops working. Every other institution is better off with a simpler, cheaper model for their investment dollars.
Financial literacy: I have been a big advocate for financial literacy for decades. Indeed, my blog The Big Picture has been an exercise in teaching investors better ways to think about money, investing, behavioral psychology, economics and so on.
Alas, the data suggest it is all for naught. Research informs us that “Efforts to increase financial literacy haven’t done much — and probably never will — to improve investor knowledge.”
Even if true, that doesn’t mean we should stop trying and so I will continue waging the good fight.
1. Tetlock is the author of “Expert Political Judgment: How Good Is It? How Can We Know? and Superforecasting: The Art and Science of Prediction.” Our Masters in Business interview with him can be found here or here.
Originally: One Question Investors Should Ask Now and Then