Concentrate on reliable predictors of return, aligning your investment horizons away from your emotions.
Leave it to Tom Hanks. Only the most acclaimed actor of our generation could have garnered an Oscar nomination for absolute silence, interrupted only by an occasional shouting match with his co-star, a bloodied volleyball named Wilson. Castaway, released in 2000, showed Hanks’s character, a pudgy executive from FedEx, marooned on a South Pacific island as the lone survivor of an airplane crash. His only companion was a volleyball that washed ashore in a FedEx package. The flick now regularly pops up on cable and remarkably always seems to draw me in, suspending my channel surfing for a few minutes. There’s just something about the drama of surviving on a deserted island that requires nothing more than watching what happens next.1
To most, a portfolio management process without frequent performance reviews and benchmark comparisons is about as foreign as a movie without dialogue or co-stars. But most asset management programs have very long horizons, where a month or quarter—let alone a day or a week—is but a statistically insignificant blip. Actuarially, even an octogenarian has a nearly 10-year time horizon. In recent talks with advisors, I asked how many had clients whose investment portfolios were designed to meet liabilities less than 10 years out. Anecdotally, I can tell you well under 5% of the advisors raised their hands.
Of course, some institutional investment programs also are designed to meet prospective payout streams that go on for decades. This is indeed a blessing because the capital markets are inherently noisy and unpredictable over the short term, but remarkably steady and predictable over the long term. But all of us succumb to the temptation to check the impact of recent market movements on manager performance. One large pension client specifically affirmed this tendency by telling our CIO that “we are long-term investors but short-term reviewers.”
What if we couldn’t evaluate performance for the next quarter or the next year or even the next three years? At Research Affiliates, we call this thought experiment the “Deserted Island portfolio.” Like Hanks’s character, we would be exiled to a remote, uninhabited island. But before we get banished to the beach, we could build a portfolio we would buy and hold, save for an annual rebalancing back to target allocations. In the interim, there’d be no cable news feed and no benchmark comparisons, nothing to reinforce the brilliance or stupidity of our portfolio selections.
Today this exercise reveals some unusually good opportunities for those willing to embrace maverick risk.
Deserted Island Logic
In the late 1980s, Paul B. Andreassen conducted a series of experiments demonstrating that investors who received no news about their stock market investments did better than those who saw the headlines. The theory is that investors often overreact to short-term news that has little effect on the long-term fair value of the company. Some 25 years later, the 24/7 news cycle and nearly continuous performance measurement cycle makes it all the easier for investors to overreact, generally to the detriment of portfolio returns.