Identify Your Comparative Advantage
Creatura advises that investors understand their edge. This point is similar to Warren Buffett’s advice about knowing your ‘Circle of Competence’ — finding what you’re really good at and being aware of where that boundary/circle ends. Creatura writes:
Prominent fund manager Bill Miller, who as the owner of the record for most consecutive years of outperformance against the S&P 500 is a person who knows something about kicking financial backsides, believes there are three sources of comparative advantage: 1) informational, 2) analytical, and 3) emotional.
Informational advantages, or knowing something that the rest of the world doesn’t know, are wonderful to have but difficult to get. The first problem is that the ubiquity and velocity of today’s news leaves little room for trading. In the 1980s, academics estimated that after fresh news broke, price adjustments took anywhere from five minutes to two days. Today, prices begin to adjust in seconds, perhaps milliseconds. The other problem is that the government has taken a particularly keen interest in the use of material non-public information. Just ask Raj Rajaratnam. Be prepared to discuss how you came by the whispers of the bid for Bymeout Pharma.
Analytical comparative advantage comes from having the same information as everyone else, but using it differently. This is the ability to come to a more correct conclusion, faster. You could have a stronger brain, or a stronger computer, or maybe you can spot the dissimilar jigsaw puzzle pieces that fit together after all, even though they didn’t seem to at first.
Emotional comparative advantage is something else altogether. It comes from within, as your intellectual waters remain clam while others make poor decisions based on panic, greed, extrapolation, and faith. This advantage has more to do with how you are wired and is probably something that is very difficult to learn. Again, who are you?
There are other comparative advantages. Perceptual. Cost. Patience. Speed. Network. Experience. It really doesn’t matter which is yours, but it is of existential importance that you have one. Otherwise you are entering the battle unarmed.
Be Skeptical Of The Media’s Content
The people running the media aren’t investment analysts, they’re simply journalists. As Creatura rather bluntly puts it:
Not CFAs or MBAs or even an online minor in Economics. They are very smart, can write to a deadline, and love a good metaphor if you can spare one. But they don’t do the math or even care about the math. They want the narrative, the plot, the story. They live in a verbal world where the numerical realities of a business event are secondary… Follow the media’s incentives. They are maximizing ratings, not returns. Their value-add is the rapid transmission of raw information. This is entertainment, not analysis. Ingredients, not the meal. Don’t use any media outlet’s conclusions, advice, or insights.
Be Different & Correct
There are two main ingredients for investment success: i) be different ii) be correct.
This point is similar to what Howard Marks shared in his Oaktree Memos. You can’t hope to consistently outperform the market by investing alongside the consensus. As John Templeton once said, “If you want to have a better performance than the crowd, you must do things differently from the crowd.” However, being different is just a prerequisite. You also have to be correct while staying different.
The challenge of ingredient 1 is to figure out if what you believe is materially different from what the consensus really is. You may have acquired better information before the competition, but if it isn’t significantly different from what others already think, you don’t have anything. You can’t know different until you’ve determined same. Like navigating with a map, if you don’t know where you are you, you will have a tough time determining where you are going. Where is the consensus anchored – mathematically but also perceptually? Current expectations aren’t always expressed through earnings or revenue forecasts alone. Timing of new product introductions, use of cash flow, dividend rates, management transitions, and divestitures are are all expectations, too…
Different comes from within. It takes curiosity, reason, intellect, hustle, creativity, confidence, suspicion, the strength to be non-accepting, and a willingness to stand alone. Not a common combination of attributes. Also, being different is not enough. The second and final ingredient for investment success is to be correct. Being different and incorrect can be spectacularly disastrous: Oh, the humanity! … And how will you know if you’re correct? That’s the easy part. The market will let you know.
Don’t Rely On Academic Qualifications
In the pure search for investment return, academic degrees mean little. Yes, classroom training can give you some tools, but it is how you wield them that matters. There are certainly many examples where the exoskeleton of academic pedigree offered no protection from financial carnage. Roger Lowenstein’s book ‘When Genius Failed’ is a modern tragedy describing how an academic A-Team with degrees from Harvard, MIT, Stanford and University of Chicago, whose members including a Vice Chairman of the Federal Reserve, several professors, and two Novel Prize Laureates, (spoiler alert here)… failed. When you look at their portfolio just before its collapse, “genius” isn’t the first word that comes to mind: 25:1 leverage on just under $5 billion in equity, with $1.2 trillion (yes, trillion with a “t”) in notional derivative value off balance sheet. At the time, the firm’s implosion destabilized the entire global financial system.
In contrast, look at the anti-heroes of another book, Michael Lewis’s ‘The Big Short’, which describes an unrelated gaggle of investors who successfully navigated the housing bubble. They included a one-eyed heavy metal fan with Asperger’s. Two guys who set up a hedge fund in their garage. An abrasive lawyer-turned-analyst-turned-manager. True, all of them had some level of academic training, but that wasn’t their currency. These were the outsiders, the investment industry’s equivalent of the ‘Star Wars’ bar scene. They were the handful, among the hundreds of thousands of professional investors, who spotted and executed the biggest trade of a generation.
Beware taking shortcuts with social signals such as college degree, employment history, awards received, or fame in general. Also bury all of your preconceptions. You won’t be served well by believing the stereotype: the paunchy man with the “aw-shucks” southern drawl, the blonde with hair a bit too tall and heels a bit too high, the quiet new employee with pimples. You don’t want to be the one to find out, too late, that they are the smartest people in the room.
Learn Continuously & Read Broadly
Creatura points out that beyond basic knowledge like finance, accounting, and economics, many successful investors come from a background of varying disciplines (physics, engineering, mathematics, sociology, philosophy, literature, history, political science), suggesting that there