In Search of the Holy Grail of Investing (part 1)

When I was just starting out in the investment game, I had a mentor who told me that the one thing he wished he could have would be a copy of tomorrow’s Wall Street Journal. If he knew what stock prices would be the next day, he could make a fortune. That was his version of the Holy Grail of Investing.

In the 1980s, Hank Greenburg, head of the insurance giant AIG, once told an incoming class of new recruits to the firm “All I want in life is a small unfair advantage.” That was Hank's Holy Grail.

For me, the Holy Grail of Investing is having a clear understanding of the major drivers of stock prices and stock market returns. This knowledge would be based not on clairvoyance or cheating at the game, but rather on facts and evidence that would explain why stock prices move the way they do. If I had this level of knowledge and understanding, it would be my Holy Grail. 

I want to believe it does. But I don’t expect to actually find “The” Holy Grail because it’s really just a myth. However, I do expect to get close enough to the Grail to make a real difference in my overall investment performance. Here are some of the characteristics of the Holy Grail as I perceive it.

The main idea is to set up a vetting process for the products and services that are marketed to investors by the investment industry. Another vetting process will be set up for the claims, assertions, and revealed wisdom that emanates from academia and the financial punditry.

Here is an example of a claim that is widely promoted by the investment advice community. It is impossible to know when the market will go down and when it will go back up. Therefore, the best approach for investors is to stay fully invested at all times.

The problem with this assertion is that it ignores the need for investors to manage the risks that are part of the investment process. When the market Is doing down, why should an investor sit idly by and watch the value of her account decline month after month, for years at a time? This violates the idea of common sense and basic risk management.

False claims, dubious assertions, and deceptive sales practices can be found in just about every type of business. In the investment business it’s especially easy to fool people because the economy and the markets are maddeningly complex.

Brokers, advisers, and planners are skilled at capitalizing on this complexity to get their clients to do whatever they say. Advisers have a financial incentive to keep their clients fully invested in the market at all times, regardless of what the market is doing. Why? Because if they were to advise a client to reduce exposure to market risk, and it turned out that they were wrong, they would risk losing the client. Therefore, the adviser will always tell the client that the safest thing to do is stay fully invested.

Those who manufacture and sell investment products and services (hereafter the sell side) have a great advantage over those who consume these things (hereafter the buy side). Due to the complex nature of the financial system, the sell side can easily spin the facts in a way that is virtually undetectable to the buy side.

 For example, suppose the market was down by 10% from its recent high price, and the client called up and asked whether she should cut back a little bit on her equity exposure. The adviser, who knows all the jargon of the business, could easily come up with reasons to stay fully invested. The economy is growing. Employment is low. Inflation is under control. etc. etc.

The client doesn’t have the knowledge to counter-argue these points, so she just throws up her hands and says, “o.k. I’ll stay in the market.”

This jargon advantage enables bad actors to engage in all kinds of misbehavior, like making exaggerated performance claims, over-promising about expected outcomes, or putting their own financial interest ahead of their clients. I should also point out that not all sell-siders are bad actors. There are many who take their fiduciary duty seriously and deserve respect and admiration.

Here is a brief sample of questions that can either be answered truthfully, or with enough spin to trick even the most sophisticated buy-siders into doing dumb things with their money. I will be addressing these and other questions as we move through this series of articles.

Fair Value is one of the more "slippery" concepts in investing. What is fair value? How is it calculated? Who is it fair to? Why doesn't every stock trade at fair value if it's actually fair? If there is no "fair" value, how do you know when you're overpaying for a stock?

All good questions, and the answers are elusive, at best. Impossible, at worst. 

Valuations – are high prices always followed by low returns?

Investor behavior vs. Market Behavior – which has more influence on outcomes?

Recessions and bear markets – Are Forecasts worth anything?

Passive vs. Active investing – Which is Better?