We’re forever trying to find good metaphors to describe the basic thesis behind long volatility type managed futures programs, which we summarize as basically accepting small but consistentlosses, in exchange for less frequent, but much larger gains. What we probably don’t explain enough is why and how those consistent losses happen. They happen because in baseball terms – it’s because they are swinging at every pitch. In poker terms – it’s because they are playing every hand the same way – always calling with xx pair, always folding when the hand doesn’t improve.
I’m a good poker player….[and] I’m also a good stock picker… But I don’t consider myself to be a great poker player or a great stock picker. Why not? Because I get bored with the interminable and rigorous discipline that being a great poker player or a great stock picker requires. And I bet you do, too.
To be clear, it’s not the actual work of poker playing or stock picking that I find boring. I could happily spend every waking moment turning over a new set of cards or researching a new company. And it’s certainly not boring to make a bet, either on a hand or a stock. What’s boring is NOT making a bet on a hand or a stock. What’s boring is folding hand after hand or passing on stock after stock because you know it’s the right thing to do. The investment process that makes a great poker player or a great stock picker isn’t the research or the analysis, even though that’s what gets a lot of the attention. Nor is it the willingness to make a big bet when you believe the table or the market or the world has given you a rare combination of edge and odds, even though that’s what gets even more of the attention. No, what makes for greatness as a stock picker is the discipline to act appropriately on whatever the market is giving you, particularly when you’re being dealt one low conviction hand after another.
Investment discipline suffers under the weight of dullness and low conviction in at least four distinct ways here in the Golden Age of the Central Banker.
Dr. Hunt sure has a gift for simplifying the complex (tell all your friends in the Houston area to go hear him talk), and while he wasn’t talking about systematic managed futures/global macro strategies per se, there’s a lot to take away from his comments.
One, we’re hardwired to get bored… to seek out action, and let that boredom cause us to think an unattractive opportunity is suddenly attractive. He had this quick story on Stanley Druckenmiller to hammer that point home:
“…January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy at 104 times earnings. This is nuts…we’re going to step aside, wait for the next fat pitch.
So like around March I could feel it coming. I just … I had to play. I couldn’t help myself. And three times during the same week I pick up a phone but don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. “
If living in the NASDAQ bubble can make Stan Druckenmiller convince himself that stocks trading at >100x earnings were a high conviction play only a few months after selling out of them entirely, what chance do we mere mortals have in not succumbing to 6-plus years of the most accommodative monetary policy in the history of man?
Two, we’re hardwired to pay really good attention to what’s in front of us…but not so good at weighing what’s in front of us against what’s behind us, or what may be better for us in the future (except those who pass the marshmallow test, I suppose).
Humans are excellent at prioritizing the risks and opportunities that they are paying attention to at any moment in time, and excellent at allocating their behavioral budget accordingly. It’s why we’re really good at driving cars or, in primate days of yore, surviving on the Serengeti plains. But if asked to compare the risks and rewards of a current decision opportunity with the risks and rewards of a decision opportunity last year (much less 10 years ago), or if asked to compare the opportunity we’ve been evaluating for months with something less familiar, we are utterly flummoxed.
Now, Hunt’s solution to these problems is to “take what the market gives you.” An overly simplistic solution, you’re likely to think at first, until seeing the detailed example he follows that with. But our brains (perhaps because they are hardwired that way…) jumped right to systematic managed futures/global macro type strategies, for it is those types of strategies which insure you play every hand consistently and don’t get bored. It is those strategies which make risk normalized sized bets across dozens of global market sectors, not being drawn like a moth to the hot sector or current narrative (Oil, interest rates, etc). Systematic strategies cure many of the human hardwiring which can make us “good” investors, not “great.”
PS – in the Houston area, go hear Dr. Ben Hunt and a panel of 6 professional managed futures and global macro fund managers explain how and why they approach the markets the way they do. The event is free to attend.