The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management


Investment Beliefs: Separating The Real Stuff From The Fluff

Investment Puzzle

Hiring and firing decisions by plan sponsors are habitually poor.1 They classically hire the 'hot dot' manager and fire the 'Not (so)-Hot-Dot' one (i.e. the underperforming manager). Because good managers don't stay 'down' and hot managers 'cool off,' plan sponsors often make precisely the wrong decision – sell low and buy high. In this process, we understand the agency problem: how can a plan sponsor tell their board, "We are hiring a manager with a weak record!?" Of course, they cannot. But wait, it gets even better. What if the plan sponsor adds: "And we are firing that one high performer!" Good luck with that pitch!

Plan sponsors face the ongoing challenge of selecting superior managers. In our research, plan sponsors overwhelmingly identify investment philosophy and process as the key determinant in making their decision.2 Presumably a manager's performance record defends the value of their investment philosophy and process. Logically then, the selection process needs to start with performance numbers over a complete cycle. After all, without defensible numbers there's always the choice to go passive.

'Fluff Statements'

Beyond the numbers, what explains the good track record? Why would the superior results persist? Too many firms have what we would call 'fluff statements.'3 A fluff statement sounds perfectly logical but doesn't help us understand why a firm could outperform. The most blatant example would be, 'We buy low and sell high by employing hard working, smart professionals.' (Remarkably, many investment firms identify their strategic edge as 'smart staff' and 'hard work.') At face value, this statement makes perfect sense. But it tells us nothing about the competitive edge. All firms try to buy cheap and sell dear, and all firms ‒ that we've encountered ‒ have smart, hard working professionals.

To take a real example of fluff from a firm's statement, consider this one:

"We seek to build models of both the fundamentals and of a macro overlay and use both to forecast security returns."

Lovely, but what have you told us about competitive advantage? And forecasts, really, are we not beyond that failed endeavour? Perhaps James Grant has put it best with "how rarely the light of prediction illuminates the darkness of the future."4 What firm hasn't tried to do some or all of this? If you are in the investment space, is this not what you do? What we want to know is what are your investment beliefs and practices that allow you to add value. A good investment beliefs statement includes a valid competitive edge. It answers the question, "How can we hope to win in a fiercely competitive environment?" A savvy investment manager recognizes that all humans suffer from overconfidence bias ‒ I'm in the top half! ‒ so they need to think carefully about the reality of what it takes to actually outperform.

Minimum Requirements

The following statements are candidates for meaningful competitive advantage rather than fluff. Please note that competitive advantage does not guarantee alpha, but it does provide the greatest likelihood of success. They should be among the minimum requirements when selecting an active manager.

These are just three of many possible 'fluff-less' statements. But each of them merits further exploration because they have only the 'kernel' of legitimacy. They require follow up questions to fully understand their robustness, but they pass the first test ‒ they are not fluff.

James Ware (CFA),, is the founder of Focus Consulting Group. Michael Falk (CFA) is a partner and chief strategist on a global macro hedge fund.

1. Goyal and Wahal, Journal of Finance, 2008 and Stewart, et al Financial Analysts Journal, 2009

2. Jim Ware speech to Global ARC, Fall 2010. Data collected real-time from audience of 100 institutional clients and plan sponsors.

3. The phrase 'fluff' is taken from Richard Rumelt's book, 'Good Strategy, Bad Strategy' (Crown Business, New York, 2011). He writes, "Fluff is a form of gibberish masquerading as strategic concepts or arguments." Pg. 32

4. James Grant newsletter

5. See Scott Page's book, 'The Difference: How the Power of Diversity create better groups, firms, schools, and societies,' (Princeton University Press, Princeton, 2007)

6. Opening quote from Michael Mauboussin's "Investing with Style" (the consilient observer, November, 2002)

7. While no direct evidence exists that John Maynard Keynes stated this, he continues to receive much of the attribution. John Maynard 22/keynes-change-mind/

8. Paul Kleindorfer, 'Reflections on Decision Making Under Uncertainty' (INSEAD WP, 2008). He writes, "… arises undoubtedly from our biological heritage in seeking meaning and order in life so that we can continue to function without undue neurosis" Pg. 15 and Lionel Tiger, 'Optimism: The Biology of Hope' (Simon & Schuster1979)

9. From FCG real-time survey results of CFA audiences globally, when asked, "Do you keep a decision journal?" 

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