This week, I came across a rare investing gem on Twitter. For the most part, I haven’t found Twitter to be particularly helpful in the investing arena. But a recent "Tweet Storm" — or series of tweets about the same topic — from famous investor Jim O’Shaughnessy on "Things I Know and Things I Know I Don’t Know" is pure investing gold.
I encourage you to click the link and read through the whole list. Each is short (140 280 characters or less!), so it’s a quick read.
O’Shaughnessy is a quantitative investor who has made his career identifying patterns in market data and building strategies around those observations. That type of approach naturally resonates with us at SMI, because we’re wired the same way. So not surprisingly, I’ve long been a fan of his work. (SMI ran a cover article from one of his books about a decade ago.)
While the whole list is great, there were a few specific items I wanted to highlight for SMI readers. Some may have sped by you, given the way they were framed. For example, #15:
15/I know that, as a professional investor, if my goal is to do better than the market, my investment portfolio must look very different than the market. I know that, in the short-term, the odds are against me but I think I know that in the long-term, they are in my favor.
Now, you may have skimmed that as soon as you read "as a professional investor." The thing is, in the context he’s talking about, that actually applies to you too — assuming you’re managing your own portfolio using SMI’s strategies!
Let me rephrase the first part of that to drive the point home: As the manager of your own portfolio, if your goal is to do better than the market, your investment portfolio must look very different than the market.
Now let’s add the point he makes in #16:
16/I do know that by staking my claim on portfolios that are very different than the market, I have, and will continue to have, far higher career risk than other professionals, especially those with a low tracking error target.
And again, the SMI interpretation: If your portfolio looks very different from the market, your performance is sometimes going to be very different than the performance of the market indexes!
In other words, to beat the market over time, your portfolio can’t look like the market. But if your portfolio doesn’t look like the market, there are going to be times when your performance is very different from the market.
Most of us are great at dealing with this reality when "different" means better than the market — think Sector Rotation over the past five years. But we hate this when "different" means worse than the market — DAA over the past five years.
But both are flip sides of the same coin. Those variances from the market’s returns are what allow for long-term outperformance. Which brings us back to the last part of both of those tweets above: "...I think I know that in the long-term, [the odds] are in my favor," but also "I have far higher career risk than other professionals."
SMI translation of what he’s saying: In the long run, I’m confident my strategies are going to win! But along the way, my performance may look ugly at times when compared to the market itself (or indexed portfolios). My clients may fire me at those bad times (i.e., career risk).
As your own portfolio manager, it’s key that you let these ideas get deep down inside your investing DNA. You’ve chosen strategies that have strong quantitative research backing them up, which history has shown are likely to outperform the market if given time to work. But they’re going to look out of sync with the market, and at times, the performance comparisons are going to look downright bad. Don’t fire yourself when this happens! Or perhaps more to the point, don’t fire the strategies (and move on to some other approach) at those times. Stick with them and let those long-term odds work in your favor!
O’Shaughnessy’s #18 tweet addresses this:
18/I know that as a systematic, rules-based quantitative investor, I can negate my entire track record by just once emotionally overriding my investment models, as many sadly did during the financial crisis.
That pretty much speaks for itself.
And I can’t wrap up this discussion without mentioning #24 and #25, because they’re so priceless and accurate:
24/I think I know that the majority of active stock market investors — both professional and aficionado — will secretly believe that while these human foibles that make investing hard apply to others, they don’t apply to them.
25/I know they apply to me and to everyone who works for me.
If only any of us were immune from these behavioral traits that make sticking with the long-term plan so difficult! But knowing we’re not is half the battle. At least then we can address the issue head-on and try to build in safeguards that will keep us on track when the going gets hard.
Which of O’Shaughnessy’s points resonates the most with you? Leave me a comment below and let’s discuss.
