Off-target – Human beings often focus on the wrong information and investors are no exception


Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

We have talked before about how people often end up focusing on the wrong information but, this time, let’s try and illustrate the point with a brainteaser. Imagine Jack is looking at Anne but Anne is looking at George. Jack is married but George is not. Is a married person looking at an unmarried person – a) yes; b) no; or c) from the given information, is it just not possible to say?

If you went for c), you are in good company as, when asked, apparently four out of five people will say you cannot answer the question unless you know whether Anne is married or not. But that is the wrong information to focus upon as her marital status is irrelevant. The answer is a) – either a married Jack is looking at an unmarried Anne or a married Anne is looking at an unmarried George. The way to solve this puzzle is by imagining Anne is either married or unmarried and then playing either scenario though in your head – the answer then reveals itself.

Such lateral thinking has echoes of the Second World War tale we mentioned in Plane truth. In it, the US Air Force was on the point of reinforcing its bombers in the areas that appeared most shot up after they had returned home from missions – until a statistician raised the question of the planes that never made it home and suggested instead reinforcing wherever the survivors remained unscathed.

Nor – it goes without saying – are investors immune from being side-tracked by the wrong information. Towards the end of 2014, for example, GMO’s James Montier published a white paper describing shareholder value maximisation as The world’s dumbest idea – the paper’s title itself a nod toward a line used by business guru and former General Electric boss Jack Welch in an interview in 2009.

Montier concluded shareholder value maximisation “has not delivered increased returns to shareholders in any meaningful way” and indeed “may actually have led to poorer corporate performance”. “Only by focusing on being a good business are you likely to end up delivering decent returns to shareholders,” he added. “Focusing on the latter as an objective can easily undermine the former.”

In a similar vein, companies are all too fond of using their own earnings per share (EPS) number to gauge their performance – a natural consequence of this being that the measure is then used to set the remuneration of executives. And a natural consequence of that? That “the majority of companies are willing to sacrifice long-run economic value to deliver short-run earnings”.

That line appears in The success equation: Untangling skill and luck in business, sports and investing, a book by one of The Value Perspective’s favourite investors, Michael Mauboussin. He goes on to argue: “Theory tells us that the causal relationship between the growth of EPS and the creation of value is tenuous at best.”

To make his point, he compares EPS and sales growth for more than 300 large non-financial companies in the US over two consecutive three-year periods and actually finds a negative correlation. “In addition,” he continues, “the rates of growth for earnings rapidly revert to the mean, which is what you would expect to see when luck plays a large role in the process.”

Over time, few things – or people – can escape the powerful influence of mean reversion and we would never suggest fund management was an exception. Mutual fund returns are of course mean-reverting but thankfully – at least to The Value Perspective’s way of thinking – Mauboussin is able to point to research that suggests skill does play a part in investment.

Streaks of outperformance by fund managers, he notes, do happen more often than one might expect from mere chance alone. In that regard, the ability of an investor to think differently from the crowd and consider all the available possibilities – rather than, say, becoming hung up on Anne’s marital status (the above example also coming courtesy of Mauboussin) – is unlikely to prove a disadvantage.


Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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