Value Perspective Quarterly Letter - 1Q 2015
Results matter – but so does how they are achieved
Human beings tend to focus on outcomes. There aren’t many fields where this rings more true than in the world of investment. Conventional wisdom suggests that a good investment is when you make money and a bad one is when you lose money. It’s as simple as that. Or is it? One of the fundamental concepts in investment is process – if you don’t understand how results have been achieved then it’s very difficult to repeat them if they were good, or to change them if they weren’t. All too often, investors focus solely on outcomes at the expense of process. This is understandable – results matter. Results also tend to be black or white and easy to understand, whereas evaluating a process can be far more subjective.
The most common pitfall is to assume that all good outcomes are the result of good processes and vice versa. Results are easy to measure, but they may be a poor teacher. As Michael Lewis argues in his excellent book Moneyball, the best long-term performers in any endeavour that depends on probabilities – be it investment or sports team management – tend to be more focused on getting their process right then they are on results in isolation..
Acknowledge the role of luck
So, what are we to do as investors? The first thing is to acknowledge the role of luck. Because probabilities only express a likelihood that something will happen, they don’t guarantee it, we have to accept that, good decisions will sometimes lead to bad outcomes, and bad decisions will sometimes lead to a fortuitously good outcome. A useful way to work out the degree to which luck plays part in a game is to consider how easy it would be to lose on purpose. In tennis, for example, it is quite easy to lose deliberately, but investment is a different matter entirely. Over short time periods there is a huge element of luck involved, and it would actually be quite hard to construct a portfolio guaranteed to underperform over the next three months. This is why an investor’s true ability cannot be appraised over the short term. Over the long-term, however, process dominates outcome.
Consistent long-term results require a process that is repeatable
An investment process must be rigorous and repeatable. The reason value investing is such a powerful strategy is that it has more than 100 years’ worth of history to show that it’s a process that outperforms. This long-term track record is what makes it so compelling. Obviously, value can underperform over shorter time periods, and this is what makes it a difficult approach for many to adopt, but such periods are simply too short for the strength of the process to outweigh the impact of pure chance. We invest on a five-year time horizon, and it is over these longer periods that value investing can really demonstrate its power.
Target small gains to compound big returns
One of the reasons we avoid commenting on short-term performance is that it gives the false impression that our results over such periods can be definitively explained. The performance of a skilful investor is likely to look very similar to that of a lucky investor in any given quarter – the difference between the two only emerges over the longer term. If 40% of our investments are mistakes and the other 60% go on to outperform over the long-term, we stand a very good chance of delivering strong relative and absolute returns. Reducing our mistakes by just 5% would generate enormous value and that’s why we strive to be better fund managers tomorrow than we were yesterday.
The Value Perspective team
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.
This article is intended to be for information purposes only and it is not intended as promotional material in any respect. Reliance should not be placed on the views and information on the website when taking individual investment and/or strategic decisions. Nothing in this article should be construed as advice. The sectors/securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy/sell.
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.