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January 2018

The art and science of investing: conversation with a client


by Rona Birenbaum  |  Add Comment

Brain illustration

Recently a client sent me an interesting note ending with two excellent questions about how our investment managers keep their feet on the ground. I enjoyed his note, and decided to share both the note and my answers with you. 

I’ve just read the trailer of a book called A First-Class Catastrophe - The Road to Black Monday by Diane Henriques. 

I found it interesting reading, because I lived through that period – when hedging, futures, and mathematical modelling were born and applied, without anybody really understanding the mechanisms and risks involved. 

Geeks in banks helped with emerging computing technologies from Silicon Valley investment models, such as “random walk,” where randomly-picked stocks out-performed carefully selected ones. Indexing followed … and on it goes. I’m afraid this is continuing with Trump undoing a whole bunch of regulations – and with what consequences? 

Here’s how ridiculous it was: Back in the 90s Goldman Sachs from NY was making a proposal to us on listing our zinc business on the London stock market. The young nerd from NY, who was in charge, asked us why we were producing zinc metal, when he could make more money just playing the zinc futures and hedges in the market? 

They did not get the contract. And we know what happened to these guys in 2008. 

I read and support your (our) investment managers’ comments and convictions about sound understanding of fundamentals underlying the stocks they invest in. Likewise, I have always been leery about speculative actions – particularly on interest rates, oil prices, etc. – which are always a symptom of fundamentals changing structurally. 

So when reading this book trailer it occurred to me to ask you: How well are our investment managers using the latest technologies/models to their benefit? And if they are, are there methods/processes by which they keep their feet on the ground, and avoid straying to La La Land?


Great questions! Following, my answers.

By the by, I wonder if the young NY geek ever thought through his question about why you didn’t just play the market, instead of actually producing a product. Aside from the inherent risk, did he wonder if it might be a bit difficult to play the market, if everyone decided to follow his advice? 

How do portfolio managers use the latest technologies/models to their benefit? 

There are a few primary methods:

  • Sophisticated screening tools allow for company and economic data to be captured and analyzed with immediacy. This enables managers and analyst to quickly identify and assess changing information, and incorporate it in their valuation models. 
  • Today’s modelling software also allows them to regularly stress-test their portfolio under a range of market and economic possibilities (however remote) such as: interest rates rising faster than expected; oil prices spiking; US currency plummeting; global recession). This allows managers to calculate value at risk under a range of both extreme and high-probability criteria.
  • What most managers don’t attempt to do is value emerging technology companies that could be the next Google. Those companies appreciate on speculation before they have much in the way of earnings, making them un-investable if you care about risk. That being said, managers do pay attention to new technologies in terms of how they may represent a way to make the companies they do want to invest in more profitable, or to the degree they are a threat to an incumbent’s business model.

Are there methods/processes by which they keep their “feet on the ground?” 

Yes. There is an art and a science to successful long-term investing, both of which keep good investors grounded: 

  • The science involves the analytics that I refer to above. 
  • The art is what distinguishes the best portfolio managers from the merely mediocre or downright awful. I characterize it as:
    • Believing in the merit of their investment process
    • Discipline – adherence to the investment process in good times and bad (both nominal and relative)
    • Ability to avoid the distractions/noise of the media and industry in general
    • A focus on the end investor.

So, when hiring active portfolio management, look for individuals with focus and discipline. These will be demonstrated by their use of a robust, consistent process for making investment decisions. 

In other words, ensure that they apply both the art and the science of investing in their work.

 

This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.


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