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Everyone’s a winner

Does anyone really have the midas touch?

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Ian Millward
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Have you ever wondered why some people seem to have the Midas touch when it comes to picking investments?

Whatever they touch rockets in value allowing them to regale you with stories of their intuition, wisdom, and generally superior decision-making capabilities. It can leave you feeling a little inadequate, particularly if your own experience of investing is that your money is the kiss of death to any fund you invest in.

How do we account for this? And more importantly, how do we change it?

One of Derren Brown’s elaborate ‘tricks’ may provide a clue. In 2008 he convinced an unsuspecting single mother of a foolproof system for picking the winner in a six-horse race. The evidence was irrefutable. She received an anonymous text predicting the winner of a particular race and, lo and behold, her horse came in. The following week the same thing happened and so on. After 5 weeks and 5 wins she promptly bet her life savings, and more, on the sixth race … only to lose (albeit the show changed the bet and made sure she was paid out anyway).

But how did it work?

It worked because she was originally one of 7,776 people who all received an anonymous text. In the first race there was a one in six chance of success which meant that 1296 people received a tip for race two. And so on until race six where we are left with just one person.

By this point she was so convinced by the success of the ‘system’ that she was prepared to bet everything. Let’s think about this for a moment. Surely, any rational person knows this is nonsense. Yes, knowing the form of the horses, the jockey, conditions etc may increase your odds but a system that guarantees winners cannot work. And yet she was utterly convinced.

That is because there is a second element at work here whereby, we are a little bit too ready to credit skill over luck. For example, did you know that 90% of professors regards themselves as above average teachers? If they can get the maths so wrong, what chance have the rest of us!

So, what has this go to do with picking investments? I believe there are about 3,000 investment funds to choose from in the UK. Someone must be top, and someone must be bottom. Again, almost by definition, to occupy either slot you must have made some kind of fairly bold decision as safety lies in sticking with the pack.

Of those funds that perform well over one year, a number will fall by the wayside in year two and so on. After 3,4 or 5 years we are left with our ‘star’ manager. Even then, if it is often terribly misleading as one stratospheric year can really skew the picture but let’s ignore that. There will be a fund (or funds) that does well every year.

A common rebuttal at the moment, might be ‘ok clever clogs, how do you account for Terry Smith or Baillie Gifford?’ However, by definition, they are part of our sample and, just like our professors, both they, and we, are predisposed to attribute skill over luck.

Now, at this point I should say that we do include both Terry Smith and Baillie Gifford in many of our portfolios. We do this for several reasons. The overriding one is that we like to include managers that think and act differently to the index and each other.

I should also say that we believe that investment decisions are not as random as backing the horses and there is more scope for skill and judgment.

However, even ‘star’ managers come and go. Most drift gently away to be quietly forgotten about but I recall a gentleman called Peter Young winning a hatful of awards in the early 1990’s before blowing up in a web of deceit and skulduggery that makes Woodford appear saintly.

And moving on to Woodford. For every person who backed Terry Smith in 2015 there would be another who backed Neil Woodford. Who was the better decision maker at that point (albeit perhaps the warning signs were there to later move from Woodford)? However, in statistical terms they are just the bookends to our sample group.

So back to the point. What do we learn from this?

What we should learn is awareness. The big winner with the Midas touch was probably a lot luckier than they imagine. Don’t be too seduced by past performance and don’t draw a straight line through the past to draw conclusions for the future.

That is why we build our portfolios around a core of tracker funds. To us it is a ‘no brainer’ decision. Why take such a random chance of success (and more to the point high chance of failure) when there is a cheap and easy solution that pretty much ensures above average performance. Where we include active managers, it is in smaller proportions, either in a sector that doesn’t lend itself to tracking or to introduce a different investment style. We might hope for outperformance, but we are not promising or relying on it. As ever, success lies in balance and diversification.

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