Content provided by Rusty Vanneman, CFA, CMT, Chief Investment Officer
Question: Ten years have passed since the onset of the financial crisis. What about the past decade has changed your thinking about the economy, financial markets, or investing?
While I honestly think most of my investment philosophy and approach remains essentially the same, there are degrees of emphasis that have changed. I’ve been in the profession for nearly 30 years, and I’m sure 30 years from now, degrees of emphasis will change again.
For instance, I learned a lesson more than 20 years ago as an analyst at Fidelity Investments (FMRCo): A good portfolio manager doesn’t just buy and sell securities and build portfolios, he or she is also an effective communicator with the ability to make a constructive impact with his or her ideas. For investors to have a positive investing experience, they need to understand how a portfolio behaves in various environments. Educational and transparent communication is critical to manage expectations and eliminate surprises, primarily because the gap between expectations and reality generates most of investing (if not life’s) disappointments.
For many years, I have subscribed to a notion attributable to Warren Buffett and Benjamin Graham. In the long-term, the market is a weighing machine; valuations and fundamentals ultimately determine prices. In the short term, the market is a voting machine; sentiment and emotions dominate. I still believe this is true, and valuations remain my investing North Star. But I appreciate the short-term tides of emotion to be even more important than I once thought. In turn, this influences many decisions, including the timing of my investing and my communication to investors.
Early in my career, I worked frequently with traders whose views and positions on the markets were nearly as likely to be short (negative) the markets’ future direction as long (positive). Basically, we either loved the market or hated it. I wasn’t quite that extreme in my thinking then, as I could appreciate analysts’ “neutral/hold” ratings. But I still underappreciated the incredibly powerful positive return expectation of the economy, bond market, and stock market. Most investors do. Calling corrections sounds smart, and it looks good when they happen. But it’s best not to swim upstream against the powerful current of positive financial market returns. Being overly negative just doesn’t pay.
A trendy topic in answering the question above is usually answered along the lines of something about the increased emphasis on risk management. While risk analytics have definitely improved in the profession over the last decade, and that is clearly the case at CLS too, I personally feel this typical response is more about marketing than a genuine change in investing. Portfolio managers knew about risk management before the crisis. If anything, the financial crisis made investors become more tactical — meaning they could get dramatically more defensive in their portfolios than they could before. That might have been a good story to tell at the time, and in the years since, but it was absolutely the wrong thing to do as the stock market is now on the verge of attaining its best 10-year annualized return ever. (Note: The stock market would need a 20%+ gain again this year to do so, which, of course, is possible.)
One aspect of risk that still doesn’t get enough attention is the concept of tracking error. This refers to the amount which a portfolio’s return differs from its benchmark’s. Many investors, even if they cannot define tracking error, can intuitively feel the risk of dramatically performing differently from their benchmarks or whatever they compare their investments results to. Some investors understand why their portfolio might be different, and some investors simply can’t tolerate it. Quite frankly, if investors want to understand how their portfolios are being managed, they should have a good understanding of how much their portfolios differ from their benchmarks, and why.
Another change is my ever-increasing appreciation for all I’ve learned from my professional superiors, colleagues, and even people I have never met but whose writings have taught me valuable lessons. I was grateful ten years ago for everybody I learned from, and that gratitude has only grown. Bosses such as Art Lutschaunig, Eric Kobren, and Todd Clarke, and the many colleagues I have worked with, for, or supervised have all taught me a significant amount about investing, the markets, communication, effective teams, and business.
In sum, I may not be as smart as I was 10 or 20 years ago, at least when it comes to retaining and reciting a large volume of facts and figures on the markets and investing, but I like to think I might be wiser than I was then. Of course, part of being wise is being humble. Apparently, I have more work to do!