From 25iq:
Bill Gurley: “Being ‘right’ doesn’t lead to superior performance if the consensus forecast is also right.”
Andy Rachleff elaborates on the point made by Gurley: “What most
people don’t realize is if you’re right and consensus you don’t make
money.” It is a bit strange that most people don’t realize this truth
and yet it is common sense: you simply can’t be part of the crowd and at the same time beat
the crowd, especially after fees and costs are imposed. Nobel Laureate
William Sharpe famously provided the mathematical proof in a paper
entitled “The Arithmetic of Active Management.” As restated by John
Bogle the conclusion is: “In many areas of the market, there will be a
loser for every winner so, on average, investors will get the return of
that market less fees.” Of course, the part about the investors
collectively getting the return of the market is key. Being a long term
investor in the progress of the economy is a very good thing. As life
runs its course, some investors get more of that financial return of the
market than others.
A key point in all of this is that you can decide not to try to
outperform a market and instead to match it as closely as you can a very
low cost. Warren Buffett describes the motivation for this approach
well: “By periodically investing in an index fund, for example, the
know-nothing investor can actually outperform most investment
professionals. Paradoxically, when ‘dumb’ money acknowledges its
limitations, it ceases to be dumb.”
- Jeff Bezos: “You just have to remember that contrarians are usually wrong.”
This point made by Bezos is the reason why most people follow the
crowd. Michael Mauboussin explains this tendency with a simple example:
“Being a contrarian for the sake of being a
contrarian is not a good idea. In other words, when the movie theater’s
on fire, run out the door, right? Don’t run in the door…. Successful
contrarian investing isn’t about going against the grain per se, it’s
about exploiting expectations gaps. If this assertion is true, it leads
to an obvious question: how do these expectations gaps arise? Or, more
basically, how and why are markets inefficient?”
Mauboussin explains why some investments get mispriced so badly:
“Because if the crowd takes something to
an extreme, either on the bullish side or the bearish side, that should
show up in your disconnect between fundamentals and expectations. And
that is what allows you to make a good investment… Again, the goal is
not to be a contrarian just to be a contrarian, but rather to feel
comfortable betting against the crowd when the gap between fundamentals
and expectations warrants it. This independence is difficult because the
widest gap often coincides with the strongest urge to be part of the
group. Independence also incorporates the notion of objectivity—an
ability to assess the odds without being swayed by outside factors.
After all, prices not only inform investors, they also influence
investors.”
This blog has repeatedly profiled great investors who have acquired skill in knowing when to be contrarian. Buffett’s
famous admonition is: “be greedy when others are fearful and fearful
when others are greedy.” One of the best times to invest is when
uncertainty is the greatest and fear is the highest. This contrarian
admonition is fully consistent with the Mr. Market metaphor. Make the
market your servant and not your master. For example, Jeffrey Gundlach
puts it this way: “I want fear. I want to buy things when people are
afraid of it, not when they think it’s a gift being handed down to
them.” There aren’t many people like Charlie Munger: “We have a history
when things are really horrible of wading in when no one else will.”
Bucking the crowd’s viewpoint in practice in the real world is not
easy since the investor is fighting social proof. Robert Cialdini: “social
proof is most powerful for those who feel unfamiliar or unsure in a
specific situation and who, consequently, must look outside of
themselves for evidence of how best to behave there.” I discussed social
proof in a recent blog post on Cialdini’s book Influence. In
many cases, following the crowd (social proof) makes sense. Sticking
with the warmth of the crowd is a natural instinct for most people. Many
people would rather fail conventionally than succeed unconventionally.
But doing the reverse is easier said that done for most people.
Andy Rachleff: “Investment can be explained with a
2×2 matrix. On one axis you can be right or wrong. And on the other axis
you can be consensus or non-consensus. Now obviously if you’re wrong
you don’t make money. The only way as an investor and as an entrepreneur
to make outsized returns is by being right and non-consensus.”...
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