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Jan 2, 2017

You Want Proof Of That?

by David Ensor

David EnsorCanadian MoneySaver is a publication for those who wish, among other things, to understand how to invest their hard-earned savings productively to produce a positive and sustainable real return over time.

And now, in a Trump-obsessed world, in which disinformation, misinformation and downright lies have gained unusual currency, leading many to wonder what is actually true, the question arises as to what individual investors should do to protect themselves against being deceived and misled.

Of course, to compound the incipient paranoia, the investment world is not exactly without a history of scams and con-artists, whose plausibility and glibness (aided and abetted by the distorted incentives that still infest the investment management industry) have caused both financial loss and embarrassment. As well, the “smartest men in the room” are often not that smart, or frauds.

Fortunately, the development of the indexed, passive investment approach provides one means to ensure that your returns are better than those of most of the so-called “professionals”, as long as you pay attention to costs and asset allocation and do not try to go too far off-piste into less transparent exotica.

However, if you wish to take a somewhat more independent approach, what are you to do? And how can you be sure that you are not being deceived?

      I.         Be very careful about how and where you obtain information. This may seem obvious, but it is remarkable how many investors confuse facts with opinion; opinions are not facts. Of course, you also need to be sure that the sources of your facts are verifiable and trustworthy. One way to achieve this is to cross-check independent sources, while being wary of the “news releases” that are increasingly being written by systems or artificial intelligence.

    II.         When researching a particular company, go to the source. Read the actual regulatory filings on SEDAR (Canada), EDGAR (US), and other equivalent sources, particularly the Management Discussion & Analysis (MD&A) and/or Risk Factors.

  III.         Maintain a suitably sceptical mindset. Paradoxically, the “crowd”, or “received wisdom” is often wrong; yet many investors feel the need to cling to so-called “social proof” in areas where they believe they lack sufficient knowledge and expertise. Ironically, active money managers (even though they would never acknowledge it) are also susceptible to this, as deviating too far from the “norm” can have career-ending consequences because of the impatience of investors and those who “lead” the industry.

   IV.         Think deeply. This may sound naïve, but as the well-respected Howard Marks has said: “To achieve superior investment results, your insight into value has to be superior. Thus you must learn things others don’t, see things differently or do a better job of analysing them— ideally all three.” If you are unwilling or feel unable to do so, you should probably stick to passive, index-based investing.

     V.         Be intellectually curious and read widely— not just about business or finance. Again, this may sound naïve, but is a hallmark of all those investors with sustained long-term track records. Being the fox (knowing many things), rather than the hedgehog (knowing one big thing) helps.

   VI.         Recognize that you will be wrong (preferably not systematically!) and be comfortable with that. Recognize that facts and circumstances change, and be ready to factor them into your decision-making as you become aware. Try to anticipate the impact of events on your portfolio, deciding whether your original thesis for an investment has changed.

  VII.         Be patient. While there are arguments for being fully-invested over time in a passive investing style, and even in a world in which cash can be a “wasting asset” even in nominal terms, you need to recognize that it is not the frequency of success, but the magnitude that matters. As an individual investor, that does not mean putting “everything” into one investment, but it does mean being discriminating in terms of allocation and timing.

  VIII.    Understand that if something is “consensus”, money will already have flooded into it. As mentioned above, the edge comes from anticipating what will happen and become “consensus.”

   IX.         Be greedy when others are fearful. That does not mean being “stupid” and rushing in to a forlorn hope as everyone heads out. It does mean understanding that many factors are cyclical; you have to recognize the point in the cycle, as well as the level of inherent volatility or leverage. Anyone who has followed the price of O&G stocks over the past two years or so should have observed and understood that.

     X.         And as Jeff Bezos has said: “You just have to remember that contrarians are usually wrong.”

After the long list above, you may wonder, dear Reader, where “proof” comes into all this. Quite simply. You, as the individual investor and decision-maker, have to make sure that you create your own proofs, because, in reality, no-one else will do it for you unless their incentives are perfectly aligned with yours and that is very rare in the world of investment management.

David Ensor - Risk Manager & Consultant: