"Charlie Munger on “Loading Up,” Tracking Error, and Value Investing"
From Alpha Architect:
Back in 1994, Charlie Munger gave a talk to students at the USC Business School (a copy is here),
covering topics ranging from mathematics and behavioral psychology, to
pari-mutuel systems and investment management. As usual, it was a
wide-ranging and fascinating speech.
One thing that’s interesting about many of the things that emanate
from Charlie Munger’s mouth is that they reflect an understanding of
deep truths in the world, and these truths often stand the test of time.
Despite that this talk occurred over 20 years ago, we were
particularly intrigued by a few aspects related to investment management
and value investing.
From Munger’s talk:
…we’re way less diversified. And I think our system is
miles better. However, in all fairness, I don’t think a lot of money
managers could successfully sell their services if they used our system.
But if you’re investing for 40 years in some pension fund, what
difference does it make if the path from start to finish is a little
more bumpy or a little different than everybody else’s so long as it’s
all going to work out well in the end? So what if there’s a little extra
volatility?
Munger is referring here to the notion of diworsification and “tracking error.”
When you take concentrated, less diversified positions, you are doing
something different from the crowd, and your returns are therefore going
to be very different from the average – sometimes on the downside. For
this reason many are deeply fearful of taking concentrated positions.
Yet this is critical if you want to be a successful value investor. The
value investing funds – like Munger’s – that perform best over the long
run take concentrated positions and don’t hold 100+ stock portfolios.
Munger continues:
In investment management today, everybody wants not only
to win, but to have a yearly outcome path that never diverges very much
from a standard path except on the upside. Well, that is a very
artificial, crazy construct. That’s the equivalent in investment
management to the custom of binding the feet of Chinese women. It’s the
equivalent of what Nietzsche meant when he criticized the man who had a
lame leg and was proud of it. That is really hobbling yourself.
Leave it to Charlie Munger to refer to Nietzsche in the context of asset management. What is he driving at?
In “Thus Spoke Zarathustra,” Nietzsche preaches the value of
educating yourself, being faithful to yourself, and ignoring convention
and the crowd in the marketplace. Munger’s “man with the lame leg”
represents this ignorant crowd....MORE
