STREET DOGS

LIKE dogs chasing their tails, most institutional investors have become locked into a short-term, relative-performance derby. Hundreds of millions of other people’s money is routinely whipped from investment to investment based on little in-depth research or analysis. The prevalent mentality is consensus, group-think. Acting with the crowd ensures an acceptable mediocrity; acting independently runs the risk of unacceptable underperformance. Most money managers are compensated not according to results, but as a percentage of assets under management. The incentive is to expand managed assets in order to generate more fees. Yet while a money management business typically becomes more profitable as managed assets increase, good investment performance becomes increasingly difficult. This conflict between the interests of the money manager and that of the clients is usually resolved in the manager’s favour. — Seth Klarman

A “quote” often attributed to Keynes is that: “The market can stay irrational longer than the investor can stay solvent.” For us agents, he might better have said: “The market can stay irrational longer than the client can stay patient.”

The central truth of the investment business is that investment behaviour is driven by career risk. In the professional investment business we are all agents, managing other people’s money. The prime directive is to keep your job. To do this, it is imperative that you are never, ever wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors are doing. The great majority “go with the flow”. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is the largest. —