Tom Bradley is co-founder of Steadyhand Investment Management, a member of the Investment Hall of Fame and an advocate of timeless investment principles.
On the Monday of the August long weekend, a friend saw me paddling and took exception to it. He gave me a lot of trouble for playing on the water while the stock market was crashing.
I’ve had my retorts. I’m enjoying a beautiful summer day, so leave me alone. Besides, what am I supposed to do about it? And then, the key point and the purpose of this column: Why didn’t you give me a hard time on days when the market was up?
This got me thinking about asymmetry, or as Google describes it, a lack of balanced proportions between the parts of something. The interaction with my friend is one example of asymmetry in the investment industry, but there are many others.
The Holy Grail. Investors are always looking for an asymmetric bet – a stock with a lot of upside and little downside. Of course, any analysis is a matter of opinion.
Gord O’Reilly, the long-time manager of our equity fund, was one person whose opinion I could rely on. He looked at each stock from the perspective of upside and downside risk. When the stocks in his fund were on average at the lower end of his range (more upside than downside risk), it was time to give him more money to manage. Returns would likely be above average over the next five years. Conversely, when the portfolio was trading at the upper end of the range, it was time to be cautious.
Buy, buy, buy. You may have noticed that stock analysts have far more buy recommendations than sell recommendations on their recommendation lists. There are several reasons for this bias. First, it is biased toward the stock market rising over time. Analysts take a career risk by bucking this trend. Clients never forget when they missed out on a stock that turned out to be a good one or were advised to sell it. Bad sell recommendations stick around forever.
Second, analysts don’t want to jeopardize their relationship with the management of the companies they cover. I have personal experience with this. When I was an analyst, I gave a sell recommendation to a stock that I had been covering for years and knew well. After that, I had no contact with the CEO. He stopped taking my calls.
And third, sell recommendations are bad marketing. Investors are attracted to analysts (and advisors) with good stories, not bad ones.
Heads I win, tails you lose. “Where are the clients’ yachts?” is an all too accurate dig at the investment industry. Investing in stocks is a great wealth generator, but it pales in comparison to what successful investment professionals earn.
That’s partly because they’re good at what they do, but an asymmetric compensation system also plays a major role. Top executives get huge bonuses when things are going well, and are paid well even when results are mediocre or even bad. Management’s desire to retain its best people means that investment professionals are routinely overpaid for lackluster results.
The proliferation of performance fees has contributed to this asymmetry. There are some fair fee structures, but the most common – a fee of 2 percent plus 20 percent of profits, or 2 plus 20 – means no downside and plenty of upside. A base fee of 2 percent is more than a fair wage, and the bonus, well, it’s the reason there are so many billionaires on Wall Street.
In versus out. You’ve probably experienced it before. When you open an account with an investment firm, the paperwork is instant and your calls are returned promptly. The money is in your account in no time. But when you withdraw money, everything grinds to a halt. Responses are slower and for registered accounts, it can take weeks for your money to reach the new firm. In this case, the asymmetry works against you.
Good days versus bad days. Now back to my experience with paddleboarding. For many investors, good days in the markets are part of the process. They are taken for granted. Bad days should be too, but that’s not how it works.
Behavioral economics studies show that investors’ disappointment when stock prices fall is more than twice as great as their positive feeling when prices rise. For investors who check their account balances every day, this imbalance is a real challenge for mental arithmetic. Although stock markets tend to rise over time, they are only in positive territory on 52 percent of trading days.
Asymmetry is all around us. If possible, make sure your portfolio is on the right side.
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