THE LITTLE BOOK OF WHAT NOT TO DO WHEN BEHIND
2013 has taken on a rigid frown with relation to the managed portfolios. While the S&P 500 is up nearly 9%, the portfolios are essentially flat this year. Not necessarily surprised by this lack of performance given the fact that small-cap names that I choose to participate in often times create their gains in sudden, dramatic fashion, followed by months of relatively meaningless, sideways action. It is part and parcel of investing in companies with market caps below $500 million. However, this tendency toward under-performance has certainly put a damper on my ability to push forward with new ideas. Allow me to explain:
There are a couple new investment ideas I have been researching during 2013. One is a retail name and the other a regional bank. Both have the obligatory minimal risk equation as a result of restructuring within the company and apparent stability in price over an extended period of time. Both also have the equally important upside potential in excess of 3 to 4 times current price. What these names don't have is the blessing of a portfolio that is prepared to take on more risk.
There are various layers of risk management that are deployed across the portfolios I manage. One of these layers is a simple rule that disallows any increase in net exposure during periods of drawdown. I don't ever want to be in a position where risk is increased as a direct result of wanting to catch up in performance.
A devious phenomenon begins taking shape within the mind when pressured by exclusion from the markets as a result of under-performance. It is amplified further when the markets have essentially been lubricated to the point where anyone who places a dollar into the machine is assured of walking away with some form of profit. The pressure of being left out of the party creates a response that is driven on one side by greed and on the other side by fear.
The greed reflex sees the amount of capital being created, counting that capital essentially as a loss within the overall portfolio. Every dollar that is missed with every tick higher in the Dow creates a response that moves the participant closer to the investment hell that is chasing performance. Judgment becomes clouded. The barrier to entry for new positions becomes less and less. The opinions of those around you, whether social media related or otherwise, begin resonating with increased intensity. The impetus to act on greed becomes overwhelming in nature.
The fear reflex is an even greater obstacle. You see, it is fear that kept the participant out of the market to begin with. That fear, regardless of its origination, is eventually overwhelmed by greed. But what happens to that fear once greed replaces the emotion in the form of chasing performance? It is simply buried under an emotion that has taken on priority that is directly correlated to market performance. The emotion of fear is still very much functioning in the background. Only now it has greed temporarily superseding in the hierarchy of emotions. Functioning from a place of fear, regardless of how deeply buried the emotion may be, will always result in an end point that involves the loss of capital. Invariably. Every. Single. Time.
That is exactly why chasing performance doesn't work. From an emotional level all chasing performance does is bury the emotion of fear under the temporarily more powerful emotion of greed. The claws of an investor will never be dug in deep enough to withstand the inevitable mind twisting, gut wrenching games that the markets bestow upon investors several times each year. Furthermore, the entire thesis behind allocating into a chase of performance is based on the performance itself. Inconsistency in that performance instantly begins the process of questioning one's thesis. Markets are inherently inconsistent so the questioning process simply becomes a matter of when, not if.
Decisions made within a portfolio must be completely vacant of these emotions. It is all too often that even professional investors become mesmerized with the idea of a continuing advance or precipitous decline, completely abandoning any type of discipline they held onto before in favor of a Jell-O like wobble that instantly has them off balance from the onset. Consistent portfolio performance demands more than that from the individual manager.
While I am disappointed that the portfolios are not, at least, matching the S&P in terms of performance it has no influence upon my process. Similar to a game of poker, I know that if I make decisions with a positive expected value as often as possible, then it is inevitable that chips will flow my way over any statistically significant sample of hands. It is only when emotions get in the way of making decisions that have a positive expected value that the ship has the potential sink.
Next time you see a market professional chasing performance, be it a friend or a stranger, grab him by the colorful, striped leash he wears around his neck and tell him that the Post Office is hiring.
Goodnight.
