Tom Bradley is co-founder of Steadyhand Investment Management, a member of the Investment Hall of Fame and a champion of timeless investment principles.
On Monday of the August long weekend, a friend saw me paddleboarding and took exception. He gave me a hard time for playing on the water while the stock market was melting down.
I had my retorts. I’m enjoying a gorgeous summer day, so leave me alone. Besides, what am I going to do about it? And, then, the clincher and point of this column, why didn’t you give me a hard time on days when the market was up big time?
This got me thinking about asymmetry, or, as Google describes it, a lack of balanced proportions between parts of a thing. The interaction with my friend is one example of asymmetry in the investment industry, but there are many others.
The holy grail. Investors are forever searching for an asymmetrical bet – a stock that has tons of upside and little downside. Of course, any analysis is a matter of opinion.
Gord O’Reilly, the long-time manager of our equity fund, was one person whose opinion I came to rely on. He looked at every stock in terms of upside versus downside. When, on average, the stocks in his fund were near the bottom of his range (more upside than downside), it was time to give him more money to manage. Returns were likely to be above average over the next five years. Conversely, when the portfolio was trading near the top of the range, it was time to be cautious.
Buy, buy, buy. You may have noticed that equity analysts have far more Buys than Sells on their recommended lists. There are a few reasons for this bias. First, it’s aligned with the stock market, which rises over time. Analysts are taking a career risk when fighting this trend. Clients never forget when they missed or were told to sell what turned out to be a good stock. Bad sell recommendations live on forever.
Second, analysts don’t want to jeopardize their relationship with the management of the companies they follow. I have personal experience with this. When I was an analyst, I put a Sell rating on a stock that I’d covered for years and knew well. After I did that, my access to the CEO dried up. He stopped taking my calls.
And third, sell recommendations are bad marketing. Investors are attracted to analysts (and advisers) with good stories, not bad.
Heads I win, tails you lose. “Where are the clients’ yachts?” is an all-too-accurate jibe at the investment industry. Investing in stocks is a great wealth generator, but it pales in comparison to what high-performing investment professionals make.
It’s partly because they’re good at what they do, but an asymmetrical compensation system is also a significant contributor. Top performers get huge bonuses when things go well and are still well paid when results are mediocre or even poor. Management’s desire to keep their best people means investment professionals are regularly overpaid for lacklustre results.
The proliferation of performance fees has contributed to this asymmetry. There are some fair fee structures, but the most common version – a two-per-cent fee plus 20 per cent of the profits, or 2 and 20 – equates to no downside and a ton of upside. A base fee of two per cent is more than a fair wage and the bonus, well, it’s why there are so many billionaires on Wall Street.
In versus out. You’ve no doubt experienced it. When opening an account at an investment firm, the paperwork is done immediately, and your calls are returned promptly. The money is in your account in a heartbeat. When you transfer money out, however, things grind to a halt. Answers are slower to come, and in the case of registered accounts, it can take weeks before your money arrives at the new firm. In this case, asymmetry works against you.
Good days versus bad days. Now, back to my paddleboarding experience. For many investors, good days in the markets are part of the process. They’re taken for granted. Down days should be, too, but that’s not the way it works.
Behavioral finance studies reveal that the disappointment investors feel when stock markets go down is more than twice as intense as the positive feeling they get from rising prices. For investors who check their account balance every day, this imbalance makes for challenging mental math. Stock markets trend up over time, but are only up 52 per cent of trading days.
Asymmetry is all around us. When you can, make sure your portfolio is on the right side of it.
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