March 16 2022The above jumble of letters may appear a strange way to begin an investment topic. However, this arrangement has significance in terms of the way in which we view things, including investment opportunities. Indeed, in the world of behavioral finance, this can play a significant role. So, what does it mean? Quite simply, it stands for ‘what you see is all there is’. This is a cognitive bias described by Daniel Kahneman in his international bestselling book Thinking, Fast and Slow. In essence, this principle refers to your ability to accept what you see in front of you, especially if it confirms your current beliefs. You will not look to question what other information might be necessary to reach the right conclusion.
As an example, let us look at the diagram below. The question is which shape has the longest horizontal line? I will happily admit that my first reaction was to say Shape 1. On further examination however it became apparent that my initial conclusion was wrong, tricked by the direction of the tails at the end of each shape. The horizontal lines are in fact the same length.
So how does this fit in with investment and in particular fund selection. In a world of mass information availability, helped by the increasing use of technology, investment performance is much more visible, for anyone with an internet connection. This is undoubtedly a good thing. However, when viewing some of the information which is widely produced it can be easy to jump to conclusions, particularly with some of the basic information which we are seeing.
When we are looking at performance, we of course pay attention to performance over the standard 1, 3 and 5 years. Even with these figures however we are careful to ensure that they are relevant. For example, the current fund manager might not have been in place for the complete five-year period and therefore the figures shown may not provide appropriate guidance. Instead, we would look to view performance over the current fund managers tenure. There may also have been a change in, for example, the investment mandate or process. This could again render the figures shown as not appropriate. This would be something which we would take into consideration when conducting our due diligence.
To identify consistency, we continue to review performance over our preferred periods for performance measurement, including 0-6, 6-12, 12-24 and 24-48 months. Here we look at performance on both an absolute basis and relative to their sector peers. Even then however this is sometimes not enough. For example, the IA UK All Companies sector contains a myriad of funds with different objectives and investment styles. Some may invest in large cap stocks only, some only mid cap, whilst others may invest across the whole spectrum. Some may manage their fund following a growth investment style, some a value style, whilst others may be looking to generate a specific yield for investors. We would therefore in instances such as these look to create sub-investment groups so that we can compare funds on a like for like basis. Of course, we also take into consideration the risk which the fund manager has taken to achieve the returns that they have.
Analysis doesn’t just stop at the maths however, with qualitative analysis also a key part of the fund selection process. Here we take time to make sure we understand how the fund is managed, in terms of objective, investment style and process. It is also important to understand the fund managers experience and the resources which they have at their disposal to help them form their decisions. This aspect of analysis is particularly important when it comes to portfolio construction. We want to ensure that we have in our portfolios a suitable blend of different managers, for example value and growth style in the equity asset class. There can be times when there are sharp rotations, such as that seen in January, and you want to ensure your portfolio isn’t too biased.
This is perhaps a good point at which to mention our mantra when managing the MI Diversified Strategy Fund and indeed all portfolios. As said by one of the most well-known and respected investors Benjamin Graham, “investing isn’t about beating others at their own game. It’s about controlling yourself at your own game.”
So, as we can see, investment selection goes a little deeper than simply looking to see which fund has been the strongest over one time period. To bring us back to the beginning and to highlight the points drawn out, what better way to end than with a puzzle.
A bat and a ball cost £1.10. If the bat cost £1 more than the ball, how much does each individual item cost? Remember, all is not as simple as it seems! Answer at the end.
Answer: The default response for many is to suggest the bat costs £1 and the ball 10p but of course that makes the bat only 90p more than the ball. The correct answer is that the bat costs £1.05 and the ball 5p.